Biden's Pipeline Pledge Could Batter Oil Stocks

Earlier this month, Canadians celebrated an end to the uncertainty around the U.S. election. But as the dust settles, the focus is shifting to how the president-elect’s policies could pose a problem for the energy sector, both in the U.S. and Canada.

While Biden’s election ends years of political chaos and economic uncertainty south of the border, his environmental agenda puts him squarely at odds with conventional energy companies. It is feared that Biden is highly likely to make good on his campaign pledge and kill the US$5 billion Keystone XL pipeline, a 1,900-km long pipeline designed to transport Canadian crude oil to various parts of the U.S.

It remains to be seen how the energy sector (down 45% for the year to date, as of Nov 10) will negotiate with the new administration and if there will be enough political support to implement Biden’s clean energy policies geared towards reducing carbon emissions. However, there is real cause for concern for conventional energy companies already getting buffeted by plunging oil prices, global economic weakness, shrinking profits and global pivot to sustainable energy. The following undervalued energy stocks are trading at a juicy discount to their intrinsic worth, but they must brace for some headwinds over the coming months, maybe years, to close that gap.

Energy infrastructure company, TC Energy (TRP) operates pipeline and power generation assets in Canada, the U.S. and Mexico. The company’s pipeline network comprises 92,600 kilometres of natural gas pipeline, along with 4,900 kilometres from the Keystone Pipeline system.

Before the recent downdraft in equity markets, TC Energy outperformed the broader market and its peers. “Fears of the perfect storm of outside factors--rising interest rates, uncertainty over the status of Keystone utilization, and the Federal Energy Regulatory Commission's proposed tax disallowance --have been put to rest,” says a Morningstar equity report, pointing out, the company is expected to “meet its targeted 8%-10% annual dividend growth in 2021 and 5%-7% thereafter.”

TC Energy boasts US$43 billion in commercially secured capital projects in its growth portfolio. “The Keystone XL pipeline is the crown jewel of the portfolio, but its fate looks uncertain” with president-elect Joe Biden planning to kill the pipeline.  If not shelved, the project could be operational in the second half of 2023. The pipeline, the report says, will solely serve the U.S. Gulf Coast and has contracts for 85% of its targeted capacity.

“TC Energy’s broad network of crude and natural gas pipeline assets and geographic diversification will serve the company well in the low-oil-price environment, and pipeline expansions in growing regions will fuel EBITDA,” says Morningstar equity analyst, Joe Gemino, who pegs the stock’s fair value at US$52. 

Oil behemoth, Chevron (CVX) is the second-largest oil company in the United States and owns exploration, production, and refining operations worldwide. Production activities are based in North America, South America, Europe, Africa, Asia, and Australia. Its refinery footprint spans across the U.S., South Africa, and Asia.

“Historically, Chevron has benefited from an oil-leveraged portfolio that has led to peer-leading margins and returns on capital,” says a Morningstar equity report, stressing the firm is expected to “maintain its edge as it moves into the next phase of growth,” focused on leveraging its large Permian Basin position.

A COVID-19 vaccine is crucial to energy stocks. While effective vaccines have started to emerge, more successful vaccines could make their way to the market during the first half of 2021. “Once broad vaccination occurs, most economic activity has the potential to return to normal,” says Morningstar equity analyst, Preston Caldwell. “Not only will this spur a broad recovery in GDP, but we also expect the ratio of oil demand to GDP to essentially recover to pre-pandemic levels.”

As a result, there could be a near-complete recovery in oil demand, he adds. “With oil demand set to stage a strong recovery, more supply will be needed,” argues Caldwell. He cautions, though, that significantly higher crude prices are necessary to incentivize and intensify drilling activity to improve supply. Morningstar appraises the stock’s worth to be US$111.

Energy giant ExxonMobil (XOM) explores for, produces, and refines oil around the world. The company is the world's largest refiner and one of the world's largest manufacturers of commodity and specialty chemicals. It operates in North and South America, Europe, the Middle East, North and sub-Saharan Africa, and the Asia-Pacific.

Unlike its integrated peers, ExxonMobil is planning to hike capital spending to double earnings and cash flow, from 2017 levels, by 2025, and deliver a 12% return on capital, compared with 6.5% in 2019. The argument goes, Exxon holds a host of high-return projects that can leverage its superior integrated model and thus warrant the investment. “The reasoning is sound,” says a Morningstar equity report, adding “both targets are dependent on market conditions, however, and will likely be delayed given the recent drop in oil prices and reduced 2020 spending.”

Given that Exxon is the highest-quality integrated overall and its downstream and chemicals segments are key differentiators, “it stands to reason it should invest to maximize those advantages,” contends Morningstar equity analyst, Allen Good, who recently lowered the stock’s fair value from US$74 to US$76, incorporating the latest capital spending guidance, financial results, and near-term oil price assumptions.

Nevertheless, Good insists “Exxon is one of the better operators and developers in the world, and its plan includes a high portion of operated projects, increasing the chances for success.”

Integrated oil and gas company BP (BP) explores for, produces, and refines oil globally. Over the past few years, the company has been battling the multi-billion-dollar Gulf oil spill lawsuit. It recently reached a settlement with the U.S. government, and “while BP remains on the hook for US$23 billion, to be paid over the next 17 years, the recognition of a reliable estimate for all remaining liabilities removes a key element of uncertainty for the company,” says a Morningstar equity report, noting “with about US$1 billion per year to be paid going forward, the major outlays are behind BP.”

The oil heavyweight should be able to meet its liabilities with proceeds from asset sales of US$15 billion through 2019-21. “A relatively low hurdle, as BP has announced over US$9 billion in divestitures by the end of 2019,” the report adds.

BP has also been aggressively cutting costs and crimping spending. It has realized US$7 billion in cost reductions from 2014 levels, the bulk of which resulted from reducing workforce in the upstream segment. “While the firm already one of the lower-cost producers of its peer group, it plans to achieve another US$2.5 billion in cash costs savings from 2019 by year-end 2021 to cope with lower oil prices,” says Good, who puts the stock’s fair value at US$40 and forecasts BP’s upstream margin to improve as oil prices recover.