The 20% rise in the Canadian dollar over the last 13 months means trouble for oil and gas companies doing business in Canada, Lehman Brothers analyst Phillip Skolnick said in an equity research report. He predicted that earnings are likely to be weaker and investment opportunities will be less attractive as a result.

The stronger Canadian dollar (C$) increases operating costs, and a number of companies have mentioned the problem in recent fourth quarter conference calls. Several of them have raised costs in their guidance for 2004 financial results.

“We feel investors could be negatively surprised by the strong [Canadian dollar’s] impact on Canadian producers 4Q2003 earnings results,” said Skolnick. “Surprisingly, the stronger C$ resulted in an 8% and 4% decline in C$ denominated [West Texas Intermediate] oil and Henry Hub natural gas prices in 4Q03 versus 4Q02, despite an average 10% increase in WTI oil prices to US$31.15/bbl and an average 15% increase in Henry Hub natural gas prices to US$4.58/MMBtu.

“We estimated that the average Canadian E&P’s earnings per share in 4Q03 was flat with 4Q02 while the U.S. E&P’s increased an average of 60-65%,” he added.

Nevertheless the average discount at which Canadian E&Ps have traded relative to U.S. companies has narrowed to 5% from about 15% last year, Skolnick said. Meanwhile, the large cap Canadian E&Ps have outperformed the large cap U.S. E&Ps by 30% since year end 2002.

“We remain cautious on the shares of Canadian E&Ps with the exception of [Talisman Energy], which we rate 1-Overweight.” According to Skolnick, Talisman shares have remained at a 20% discount relative to U.S. E&Ps despite its attractive growth profile and the sale of some controversial assets in Sudan.

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