The past week has been a difficult one for investors and culture fans alike. Not only have our souls been stripped bare by the ongoing turbulence in global markets, the further free fall in oil prices and the loonies’ dive so that we can all be forgiven for feeling a bit like Hans Gruber falling off the Nakatomi Tower (RIP Alan Rickman).

Not only has the year started out so heinously, but so far in 2016 we have lost significant contributors to our cultural world – artists who were generational talents and whose contributions to their crafts were significant and who are part of the DNA of a large part of the Western World. In the case of David Bowie, many are bemoaning the fact that we may never see his like again.

It is precisely this “generational” discussion that underpins this week’s ramble. As the downturn continues there are a couple of themes developing – one of which is very negative and relates to loss, the other is what I might call the silver lining and it relates to opportunity and regeneration for I am nothing if not an optimist.

Let’s get that bad out of the way first.

As low prices persist and a China contagion seems to be gathering steam, we are beginning to see a rising groundswell of energy insolvencies (40 plus and counting in the US alone!) which will fundamentally alter the structure of the oil patch in North America. Along with this restructuring we are seeing the disappearance of household names we are familiar with – I mean seriously – Talisman is now called Repsol Oil & Gas Canada Inc. – how inspiring is that?

At any rate, as these companies sell or sink under the weight of the market, the “old guard” changes as well with seasoned execs leaving to make room for the younger generation and industry veterans, tired of the cycle, hanging it up for good. One need only go to a Ritchie Bros auction in Edmonton or Grande Prairie (also known as a US buyer’s flea market) to see the number of service companies throwing in the proverbial towel.

But out of this arises opportunity.

About a month ago, we started using a new term in the office and with clients – we call it a “generational buying opportunity” in the Canadian energy services space, driven by a confluence of events that has the potential to lay the foundation for the next generation of market leaders.

Let’s take a look at some of the underpinnings of this thesis

Low Commodity prices and point in the cycle: A lot has been made of where oil prices are at and how the world has basically come to an end. But in a world of cyclical industries, nothing is permanent and it is the participation in this inherent volatility wherein great fortunes are made or lost. The main question is how long the bottom persists and who stands to gain? To get an idea of that, the tea leaves and goat entrails need to be analyzed.

On top of all the other reports on slashed capex and declining rig counts, a recent report suggested some $380 billion of projects had been cancelled or deferred worldwide representing about 2.9 million barrels in incremental production for the next decade. This fact, when combined with natural annual declines of about 4 to 6 million barrels and demand growth of anywhere from 1 to 2 mmm barrels suggests the turn is coming.

Look, calling the bottom is for fools and the media, but there is a lot of graffiti out there – people need to start reading it. If the basic theory is to always buy something at the bottom, does it really matter is you time it exactly, or is being generally aware of where things are at sufficient.

That’s the upstream side, on the midstream and downstream side, the opportunity set may be narrower, but the participants themselves have seen nowhere near the attack on the P&L as noted in a recent Bloomberg/Calgary Herald article. This is consistent with what we have been discussing with our clients and private equity groups for the past year or so.

Purchase Price Multiples: In the current market, clearly we are not seeing much in the way of aggressive multiples or the valuations that had become more common at the peak of the last cycle, but a lot of those deals either didn’t get done or included a lot of fluff in the form of performance based earn-outs.

Today’s buyer can be more pragmatic. Instead of paying 6 to 8 times the best year of cash flow a company has ever had and hedging themselves by using a pile of iffy paper, buyers can pay a reasonable cash-based multiple of the risk-adjusted forward cash flow, while having the luxury of knowing what the target’s actual potential is by looking backwards and knowing that if run properly, the opportunity is there to reach or even exceed that during a typical hold period as the market rallies.

Canadian multiples also compare favourably to American purchase multiples as the growth story in Canada tends be more muted and the credit market is much less aggressive.

Low Canadian dollar: From the perspective of an inbound buyer, particularly American, whether strategic or private equity, the opportunity in Canada is significant. With the Canadian dollar hovering at around $0.70, there is already an implicit 30% discount on the purchase which when combined with generally lower Canadian multiples (compared to American ones), presents an opportunity to buy that is undeniable. Unless your hold period is going to be less than a year, if you buy the thesis that oil prices will eventually rise, you also need to buy the thesis that the Canadian dollar will rally. This is a built-in return.

The simplest corollary is the rise of the Canadian dollar to par at the same time as the collapse in the US real estate market in 2009-2010. It is said anecdotally that Canadian buyers saved the Phoenix real estate market, accounting for some 60% of transactions at that time, buying houses at 40% to 50% discounts with par dollars. Guess what – those houses have now recovered their value and the Canadian dollar has done its diving act, handing Canadian buyers a 130% return.

Management, Quality and Innovation: Canadian energy services businesses are some of the best in the world, operating in some of the harshest climates, with resilient management and operational teams that have been through multiple cycles. These companies are survivors who are rooted in their communities. Yes, there will be some companies that just aren’t able to make it through the downturn, but this creates a survivor bias – the ones who do make it through will by simple math have a larger market share and a greater opportunity to consolidate the market with the right financial backers. In addition, as a high cost basin facing the headwinds of low commodity prices and more fiscal discipline from their customers, Canadian service firms are constantly innovating and looking for ways to reduce the costs of finding, drilling and completing wells for their producer customers and these innovations almost always find their way into the global market – it is not by accident that the most significant advances in oil and gas technology happen in North America.

Some of the Most Significant Energy Plays and Infrastructure Opportunities in North America: Far from being a basin in terminal decline, the Western Canadian oil patch is home to some of the more significant energy plays in North America including the Montney, the Duvernay and the Horn River in NE British Columbia and North East Alberta as well as the oil sands. Canada’s reserves of oil and gas are among the top ten in the world and they will be developed. In addition, the development of LNG and pipeline infrastructure presents a long term opportunity for companies focused on development and maintenance. As the realities of the current fiscal situation in Canada and energy producing provinces become clearer, these projects will of necessity gain positive momentum.

Manageable Country Risk: Canada is a civilized country governed by the rule of law, with sound fiscal regimes, a sophisticated financial system and an educated work force. Sure, some or the recent electoral results have resulted in some regulatory instability, but by comparison, Canada is among the most stable investment destinations for energy related investment decisions. Look, I get that people complain about a changing landscape, but no one is confiscating assets. Don’t believe the hype that investment dollars are just going to leave Canada because of some short term uncertainty, the plays are just too big and the potential market too lucrative to chase them away forever.

Timing: 2016 is going to be a long year. Many analysts are forecasting continued pain for the first two quarters in the patch before things turn around. This suggests that buyers can wait and there is nothing wrong with that approach, particularly over the winter months as that is the traditional “busy time” for Canadian drilling activity. However, given the time required to close any transaction, we are of the view that whether you start in January or wait until April, if a buyer wants to be involved in the 2017 drilling season, the time to start actively engaging the market is now.

Abundant capital: The world is currently awash in capital. Private equity groups have hundreds of billions of dollars in dry powder and the opportunity set is looking increasingly shaky (Asia) or expensive (domestic US). It is only reasonable to expect that some of this surplus capital will find itself looking for opportunity in Alberta, so there will be a first mover advantage in many ways.

I understand if this is perceived as shameless flag-waving or boosterism, and an uptick in M&A activity is clearly in our interests as a firm, but we strongly believe that the Canadian opportunity is undeniable and we shouldn’t be marginalized just because we are Canadian.

I read an article about David Bowie earlier this week that talked about how when he was just getting started, he was mercilessly booed while on stage, yet he carried on and is recognized as one of the most influential musicians/performers/artists of his lifetime. Don’t underestimate the skinny guy who writes songs about Mars.

Prices as at January 15, 2016 (January 8, 2016)

• The price of oil ended the week down.
  • Storage was flat, but finished product inventories remain high
  • Production was up marginally
  • Markets are selling the storage story and extreme China fears
  • The rig count decreased
  • OPEC
• Natural gas lost ground during the week, as weather impacts abated.

• WTI Crude: $29.69 ($33.05)
• Nymex Gas: $2.103 ($2.493)
• US/Canadian Dollar: $0.6887 ($ 0.7074)

Highlights

• As at January 8, 2016, US crude oil supplies were at 482.6 million barrels, a slight increase of 0.3 million barrels from the previous week and 94.8 million barrels ahead of last year. Inventories were flat notwithstanding another almost record week of imports.
• The number of days oil supply in storage was 29.2, ahead of last year’s 23.9.
• Production was up to 9.227 million barrels per day. Production last year at the same time was 9,143 million barrels per day. Based on the numbers and a result of stubborn production levels, it is likely that negative year over year production growth in the U.S. will be delayed to later in Q1. The marginal increase in production this week came from lower 48.
• As at January 8, 2016, US natural gas in storage was 3,475 billion cubic feet (Bcf), which is 16% above the 5-year average and about 20% higher than last year’s level, following an implied net withdrawal of 168 Bcf during the report week.
• Overall U.S. natural gas consumption increased by 1.4% for the period led by residential consumption which rose 1.4% on cold weather
• Oil rig count at January 8 was down to 515 from 516 the week prior.
  • Rig count at January 1, 2015 was 1,482
• Natural gas rigs drilling in the United States were down to 135 from 148.
  • Rig count at January 1, 2015 was 328
• As of January 11, the Canadian rig count was at 203 (27% utilization), 129 Alberta (24%), 35 BC (42%), 34 Saskatchewan (28%), 5 Manitoba (28%)). Utilization for the same week last year was about 48%.
• US split of Oil vs Gas rigs is 79%/21%, in Canada the split is 49%/51%

Drillbits

• Slow news week in general
• In a bid to out-Drumpf the Drumpf, Canada’s favourite Dragon not named Brett Wilson, Arlene Dickinson, Jim Treliving or Wealthy Barber (I’m sure he has a real name), i.e. Kevin O’Leary offered to invest a whole $1 million in Alberta’s energy sector (take that Dr. Evil!) if Premier Rachel Notley resigned. In related news, his offer was politely declined.
• Suncor extended its offer to Canadian Oil Sands when its original offer was declined as expected.
• The BC provincial government submitted its opposition to the TransMountain Pipeline project saying Kinder Morgan hadn’t satisfactorily met the infamous “5 conditions”. WIdely viewed as a shakedown in advance to abject capitualtion to LNG projects, this was a clever play by the BC Liberal government as a provincial election starts to poke over the horizon. The Alberta government followed up the next day by supporting the project. Really. Is any of this the least bit surprising?
• Drumpf Watch – There was a debate on the economy last night. Not much was said about the economy.
  • Aside from the crazy kids singing the “Drumpf” pep song (trust me – search “Drumpf rally song”) the highlight of the week for me was Drumpf rallying to the defense of the “average Joe” voter by slamming the poor sap who installed his microphone at a rally, saying he wouldn’t pay, terrible, would fire that guy, disgusting. That’ll win you votes!