In the February 2014 In Focus feature we started the “recommendation” portion of the article with commodities, kicking off our answer to the headline-question “Who Benefits From a Softer Loonie?” with our top oil and gas exploration and production companies and Aggressive Portfolio Holdings ARC Resources Ltd (TSX: ARC, OTC: AETUF), Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF), Enerplus Corp (TSX: ERF, NYSE: ERF) and Peyto Exploration and Development Corp (TSX: PEY, OTC: PEYUF).

As we noted three months ago:

A positive consequence of the loonie’s decline is that Canada-based oil and gas producers’ competitiveness will increase, as their expenses are incurred in Canadian dollars while prices for their output are increasingly benefitting from better and more diverse transportation infrastructure that’s eating away at recently steep differentials between Canadian oil and gas prices and US and global benchmarks.

Energy producers with strong production-growth profiles should be particularly well placed to benefit from the currency dynamic.

In fact the weaker Canadian dollar has boosted profits for Canada’s energy producers, and, as other pressures combine to more than offset the effect of stronger commodity prices on the loonie, it appears the dynamic will persist at least through the second quarter.

As the currency reaction to today’s jobs report from Statistics Canada indicates–the Canadian dollar sank from an intraday high of USD0.9245 just before news hit the wire to as low as USD0.9161 in the immediate aftermath–larger macro forces are in play.

That Canada lost 28,900 jobs in April versus a consensus expectation of 14,200 additions is being read as a sign that the Bank of Canada could still cut its benchmark overnight cash rate from 1 percent–where it’s been since September 2010, the longest stretch without a change in the BoC’s history–before it embarks on any tightening of monetary policy.

This dovish divergence from the emerging “tightening” bias from the US Federal Reserve is driving the loonie’s weakness versus the buck. But higher Canadian oil prices may have helped the loonie stabilize in a range above recent lows versus the buck.

Of course a weakening Canadian dollar has a negative effect on US-based investors who are long Canadian equities. But production, revenue, earnings and cash flow growth for our top Canadian oil and gas producers continue to impress.

They’re seeing stronger profits due to rising demand for Canadian oil from US refiners, which has raised prices for crude produced in Alberta’s oil sands region.

Because oil is denominated in US dollars, the exchange rate gives Canadian producers more Canadian dollars for every barrel they sell, boosting their profits in their home currency.

And share prices are rising. Canadian energy stocks are leading the way on the Toronto Stock Exchange this year and are on track to outperform US energy companies for the first time in five years.

Indeed, natural gas prices, heavy oil price spreads and the Canadian dollar-US dollar exchange rate are all in favorable ranges for the Canadian energy sector.

Commodity prices remain strong, and natural gas markets could finish 2014 at their highest levels in years as producers struggle to refill inventories that were depleted during the frigid winter that hit most of the continent.

Deal-making is also picking up, as the Canadian energy industry put together CAD8.6 billion worth of mergers and acquisitions during the first quarter, up more than tenfold from the CAD750 million total for the first quarter of 2013.

The current value of mergers and acquisitions already sits at 75 percent of the CAD13.8 billion for all of 2013. Deal-making peaked in 2012 with total value in play of CAD55 billion.

Energy companies are also having an easier time in the market for financing. During the first quarter Canada-based oil and gas producers raised CAD6 billion, including CAD3.3 billion of equity and CAD2.7 billion of debt.

The total amount of capital raised in 2013 was CAD15.9 billion, with 41 percent of that completed during the fourth quarter. The sector is on track to raise CAD24 billion in 2014.

A year ago, oil producers were being forced to sell at deep discounts to the benchmark West Texas Intermediate crude price.

Oil sands production risked being locked in by a lack of pipeline capacity. Fracking had created a completely unexpected natural gas production boom in the US. Access to the Asian markets was being blocked by opposition to Enbridge Inc’s  (TSX: ENB, NYSE: ENB) proposed Northern Gateway pipeline.

US opposition to the northern leg of TransCanada Corp’s (TSX: TRP, NYSE: TRP) Keystone XL pipeline (KXL), then as now, ensured persistent bottlenecks for Canadian crude.

Many of these problems are unresolved. But the drop in the Canadian dollar has boosted bottom lines. The price differential for Western Canada Select crude has narrowed significantly. And the bitter winter was a boon for natural gas producers, pushing prices up by more than 70 percent.

KXL is still stuck in the quagmire that is the US political system. But oil producers have found other ways to move product to market, primarily reflected in a huge increase in rail shipments.

Canadian exports of crude oil by rail rose 83 percent to 146,047 barrels per day (bbl/d) during the fourth quarter of 2013 compared to 79,763 bbl/d in the fourth quarter of 2012, according to Canada’s National Energy Board.

Canadian midstream companies are building new unit train terminals that can load over 100 cars or up to 70,000 barrels of crude in one go. Analysts estimate up to around 1.1 million bbl/d of rail-loading capacity could be running in western Canada by year’s end, if terminals are built according to schedule.

Market access, as we’ve noted on many occasions, is the key to Canadian energy producers’ success. And KXL remains the big variable.

That the decision whether to grant a Presidential Permit–required for the northern leg of the project, as it crosses the US-Canadian border–has been delayed again, likely until after the November 2014 midterm Congressional elections, is a disappointment for us and the industry.

But Canada’s energy producers are finding new, cost-effective ways to get their output to market. And that’s showing up in companies’ bottom lines.

Explore & Produce

The six Canada-based oil and gas producers recommended in the CE Portfolio Aggressive Holdings are certainly benefitting from a favorable combination of macro factors.

But five of them are also executing on long-term strategies focused on production-per-share growth, while the sixth is showing good progress as it attempts to narrow its focus, shore up its balance sheet and get back to production growth.

The six of them posted an average total return in Canadian dollar terms of 16.7 percent from Dec. 31, 2013, through May 8, 2014. The US dollar return was 14.5 percent. The S&P/TSX Composite Index was up 7.8 percent and 5.8 percent, the S&P/TSX Energy Index 13.6 percent and 11.4 percent.

The S&P 500 Index posted a total return of 2.2 percent, the S&P 500 Energy Index 6.1 percent.

Market performance has been solid. More importantly, our top picks continue to put numbers that count, by the drill bit. Here’s how they fared in the first quarter.

Gas Focus

ARC Resources Ltd (TSX: ARX, OTC: AETUF) reported record first-quarter average production of 105,699 barrels of oil equivalent per day (boe/d), 11 percent higher than the first quarter of 2013 and 5 percent above the fourth quarter of 2013, driven by output from new wells at Parkland/Tower and Ante Creek.

Oil and liquids production reached a company-record 44,108 barrels per day (bbl/d), up 18 percent year over year on higher liquids production at Ante Creek, Tower and Parkland. 

Production was weighted 58.3 percent to natural gas.

Management expects production to increase over the course of 2014 as additional wells are drilled and tied into the new Parkland/Tower gas-processing and liquids-handling facility.

With the sale of 2,400 boe/d day of shallow-gas production in April 2014, ARC now expects 2014 annual average production to be in the lower end of the guidance range of 110,000 to 114,000 boe/d.

Proceeds of CAD33 million from the divestment will be used to further strengthen ARC’s balance sheet and to partially fund the 2014 capital program, including development projects in the Montney region.

The Parkland/Tower facility was commissioned in late 2013, and limited production was brought on-stream through the course of the first quarter.  Production at Parkland/Tower averaged 16,600 boe/d in the first quarter of 2014, 84 percent higher than the first quarter of 2013 and 33 percent higher than the fourth quarter of 2013.

ARC plans to drill additional wells at Tower and Parkland in 2014 and expects to fill the facility over the course of the next 12 to 18 months.

First-quarter revenue grew by 46 percent to CAD551.4 million on higher production and higher realized crude oil (up 15 percent) and natural gas prices (up 66 percent).

Crude oil and liquids production accounted for 42 percent of production and contributed approximately 66 percent of revenue.

Funds from operations (FFO) for the quarter were a company-record CAD292.3 million, or CAD0.93 per share, up 44 percent from the first quarter of 2013. The payout ratio for the period was 32.2 percent.

ARC invested CAD242 million during the first three months of the year, focused primarily on oil and liquids-rich opportunities at Parkland/Tower, Ante Creek, Pembina and southeast Saskatchewan along with spending on natural gas development at Dawson and Sunrise.

The company drilled 60 gross operated wells, including 43 oil wells, nine liquids-rich natural gas wells and eight natural gas wells.

ARC closed the quarter with a strong balance sheet, including total credit facilities of CAD2 billion and debt of CAD989 million drawn.  ARC had available credit of approximately CAD1 billion after a working capital deficit.  Net debt-to-annualized FFO was 0.9 times, and net debt was approximately 10 percent total capitalization, well within target levels.

ARC Resources, with a solid production growth profile and excellent dividend support (the current yield is 3.9 percent), is a buy under USD28.

Enerplus Corp’s (TSX: ERF, NYSE: ERF) first-quarter production improved by 13.3 percent year over year and 5 percent sequentially to 98,821 barrels of oil equivalent per day (boe/d) on record production from its Marcellus Shale assets.

Crude oil volumes were stable quarter over quarter, adverse weather conditions caused production interruptions in both its Canadian and US operations and slowed capital spending activities.  Management expects crude oil production to continue to grow throughout 2014, meeting guidance as the year unfolds.

Enerplus reiterated its annual average production forecast of 96,000 to 100,000 boe/d, though management expects to track toward the high end of the range due to the outperformance in the Marcellus. The natural gas weighting is expected to increase to 56 percent of total volume.

Higher production levels and stronger commodity prices contributed to an increase in funds from operations (FFO) to CAD220.5 million, or CAD1.09 per share, up 22 percent compared to the fourth quarter of 2013 and 27.7 percent compared to the first quarter of 2013.

Cold weather throughout North America drove a substantial increase in natural gas prices, providing additional lift for FFO.

Higher FFO, in addition to proceeds from recent sales of non-core assets, helped management pay down debt and strengthen the balance sheet, as debt-to-trailing 12-month FFO improved to 1.3 times from 1.4 times as of Dec. 31, 2013.

CAPEX was slightly lower than planned due to weather interruptions delaying some completion activities, particularly in Enerplus’ US oil assets.  The company invested CAD218 million and is on track with its full-year program.

As is the case with Vermilion, the decline in the Canadian dollar exchange rate vis-à-vis the US dollar, while positive for revenue, will increase reported CAPEX for the year. With approximately 60 percent of the capital program earmarked for US assets, management’s CAPEX forecast for 2014 is now CAD800 million, up from an original estimate of CAD760 million.

Enerplus Corp is now a buy under USD20 based on its strong operating and financial performance.

Peyto Exploration and Development Corp (TSX: PEY, OTC: PEYUF), which will report first-quarter results on or about May 14, 2014, is well positioned to reach the high end of its production potential this year after the company decided to maintain drilling intensity
through the spring breakup period.

As of mid-February 2014 Peyto was already ahead of its budgeted volume for the year with production averaging of 75,000 barrels of oil equivalent per day (boe/d).

Higher production coupled with higher gas prices would drive cash flow beyond expectations and trigger increased capital investment–and thus more production growth–and/or a dividend increase.

As of now management expects to invest CAD575 million to CAD625 million, drilling approximately 110 to 122 gross wells and adding 32,000 boe/d to 36,000 boe/d of new production by the end of the year.

Peyto, which produces natural gas at the lowest cost in the North American energy industry, last boosted its payout in June 2013.

But since the adoption of horizontal multi-stage frac well designs in 2009, Peyto has been growing production per share at a compound annual growth rate of more than 30 percent, in a world where natural gas has been trading for the most part at about USD3. And this rate of growth is set to continue in 2014 and beyond.

Based on its excellent production growth record as wells its measured approach to dividend growth in the aftermath of the Global Financial Crisis/Great Recession as well as its conversion from income trust to corporation, Peyto Exploration & Development is now a buy under USD36.

Oil Focus

Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF), like ARC Resources, posted a new company record for production during the first quarter, averaging 130,580 barrels of oil equivalent per day (boe/d), weighted 91 percent to light and medium crude and liquids. Output was up 12,900 boe/d, or 11 percent, compared to the first quarter of 2013.

Production per share was up approximately 6 percent.

Crescent Point spent CAD415.7 million on drilling and development activities, drilling 214 (173.6 net) oil wells with a 100 percent success rate. Drilling and development expenditures were approximately 10 percent under budget, while production levels in the quarter were approximately 5 percent over budget.

Crescent Point also spent CAD154.7 million on land, seismic and facilities, for total development CAPEX of CAD570.4 million.

Crescent Point generated record funds flow from operations (FFO) of CAD580.1 million, or CAD1.45 per share, up 27.2 percent year over year on strong operating netbacks prior to realized derivatives of CAD57.46 per boe (up from CAD46.59 a year ago) and better-than-expected production.

The payout ratio for the period was 47.6 percent.

Management boosted its 2014 production and FFO guidance while maintaining its CAPEX budget unchanged at CAD1.775 billion. Crescent Point should produce an average of 134,000 boe/d, up from a prior estimate of 133,000 boe/d. FFO is tracking to approximately CAD2.4 billion, or CAD5.85 per share, up from prior guidance of CAD2.38 billion, or CAD5.79 per share.

On April 14, 2014, Crescent Point announced a significant Torquay formation discovery at Flat Lake in southeast Saskatchewan. In just 12 months the company grew net Torquay production from zero to approximately 5,100 boe/d. The Torquay discovery is an extension of the Three Forks resource play in North Dakota.

In 2013 Crescent Point added proved plus probable reserves of 11.2 million boe at Flat Lake in the Torquay and Bakken formations combined. The company’s wells in the area have high rates of return, in part due to significantly lower capital costs relative to similarly drilled wells in North Dakota.

And on April 23 Crescent Point announced that it had entered into an arrangement agreement to acquire privately held southeast Saskatchewan oil and gas producer CanEra Energy Corp for CAD1.1 billion. CanEra has more than 260 net sections of land with Torquay potential, 60 of which are in Crescent Point’s core Flat Lake area, and production of approximately 10,000 boe/d.

Completion of the deal will leave Crescent Point with exposure to more than 880 net sections of land with Torquay potential.

Crescent Point continues to aggressively hedge its oil production to capitalize on the current high commodity price environment. As of April 29, 2014, the company had hedged 65 percent of its oil production for the remainder of 2014. It had also hedged 34 percent, 19 percent and 4 percent of its oil production for 2015, 2016 and the first half of 2017, respectively.

Average quarterly hedge prices range from CAD0 per barrel to CAD94 per barrel. Crescent Point also has an average of more than 15,000 barrels per day of West Texas Intermediate oil differentials locked in for the remainder of 2014.

Crescent Point’s hedges provide upside participation when oil prices increase while also providing a steady cash flow.

The balance sheet remains strong, with projected average net debt-to-cash flow of approximately 1.1 times and significant unutilized credit capacity.

Crescent Point, which is yielding 6.4 percent at current levels, is a buy under USD48.

Vermilion Energy Inc (TSX: VET, NYSE: VET) reported a 14 percent sequential increase and 21 percent year-over-year growth in first-quarter production to an average of 46,677 barrels of oil equivalent per day (boe/d), largely due to robust performance from its Mannville condensate-rich natural gas drilling program and continued Cardium-related additions in Canada, strong operational performance in the Netherlands and Australia as well as the addition of volumes related to its recent acquisition in Germany.

Output was weighted 63 percent to oil and liquids.

Based on first-quarter success management lifted its full-year production guidance from 47,500 to 48,500 boe/d to 48,000 to 49,000 boe/d.

Funds from operations (FFO) for the period were CAD205.4 million, or CAD2.01 per share, up 25.4 percent sequentially and 25.6 percent year over year. The increase was attributable to significantly higher sales volumes and improved pricing in Canada for both oil and gas, partially offset by moderately weaker realized pricing for production in the Netherlands.

Vermilion posted a first-quarter payout ratio of 31.3 percent.

Vermilion continued to benefit from its diversified commodity production mix. During the first quarter Brent crude continued to trade at an average premium of USD9.54 above West Texas Intermediate (WTI) index and USD17.79 above Edmonton Sweet index pricing.

The company’s exposure to Canadian natural gas allowed it to take advantage of a 62 percent increase in AECO natural gas pricing during the quarter. European gas pricing softened modestly quarter over quarter but remained strong relative to North American natural gas prices.  Vermilion’s European gas output received an average realized price of CAD10.29 per thousand cubic feet.

And the weakening of the Canadian dollar boosted growth in FFO due to its positive impact on US dollar- and euro-denominated commodity exposures. This contributed to a quarter-over-quarter increase in Vermilion’s realized consolidated crude and NGLs price of 5.3 percent and a 9.6 percent increase in its realized consolidated natural gas price.

At the same time, a weaker loonie increases Vermilion’s foreign-denominated CAPEX in Canadian dollar terms. Thus far 2014 devaluation of the Canadian dollar has translated to an increase in actual and anticipated CAPEX for 2014 of approximately CAD30 million. 

Combined with an additional CAD15 million of drilling-related spending, management is now forecasting full-year 2014 exploration and development CAPEX of approximately CAD35 million, up from previous guidance of CAD590 million.

Based on its solid production growth profile, we’re boosting our buy-under target for Vermilion Energy to USD64.

Note that Lightstream Resources Ltd (TSX: LTS, OTC: LSTMF) is one of this month’s Best Buys, though we recommend it only for aggressive investors who do not already have a position in the stock.

Lightstream is the top performer in total return terms among the six oil and gas producers recommended in the CE Portfolio Aggressive Holdings, at 26.2 percent in Canadian terms and 23.8 percent in US terms.

First-quarter 2014 production averaged 43,959 boe/d, weighted 80 percent to light oil and liquids, a decrease of 3 percent from the fourth quarter of 2013 due to asset sales completed during the quarter of 1,700 boe/d. These dispositions were weighted 66 percent to non-core gas assets.

First-quarter production is on target with management’s 2014 plan.

Lightstream posted first-quarter funds from operations (FFO) of CAD174.97 million, or CAD0.88 per share, flat compared to the first quarter of 2013 due to higher netbacks being offset by lower production. Operating netback of CAD81.77 for the current period was up 15 percent year over year.

Better commodity prices drove a 20 percent sequential improvement in FFO, though FFO were down 1 percent compared to the first quarter of 2013.

The payout ratio for the period was 13.6 percent.

Management estimated April production of approximately 43,500 boe/d, with activity focused on completing the remainder of wells drilled during the first quarter as well as facility construction at its Cardium business unit and in the Swan Hills area.