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Investors have reason to become bullish on the oil patch but one observer cautions that some companies may be adopting a dividend-paying structure simply to pump up their stock price.LARRY MACDOUGAL/The Canadian Press

Canadian energy stocks have been battered black and blue recently, leaving many investors running for the sidelines or pondering whether a good buying opportunity is at hand.

While markets around the world have slid from their record highs in the past month, Canada's energy sector has been among the hardest hit.

Calgary-based portfolio manager Chad Larson, of National Bank Financial, describes it as "multi-billion-dollar companies down substantially from the summer highs with pristine balance sheets and no operational issues."

The falling price for a barrel of oil – around $80 these days – has helped to drive down the share price of many of Canada's largest players in the sector. Long gone are the days of $140 oil seen before the market meltdown in 2008, when it then plummeted to about $30.

The biggest change in the market has been the growth in North American oil supply, says Jennifer Stevenson, who co-manages Dynamic Funds' energy sector funds. Technological advances in hydraulic fracturing and horizontal drilling have revolutionized the energy industry.

These innovations, coupled with historically elevated prices, have made previously uneconomical resource plays profitable. As a result, the scarcity problems once forecast for both natural gas and oil have failed to materialize, says Les Stelmach, co-manager of the Franklin Bissett Management Energy Corporate Class fund.

Today, natural gas is abundant in North America, and prices are low.

Like gas, oil has increased in supply. At the same time, Canadian producers have faced challenges bringing product to the global marketplace as proposed major pipeline projects such as Northern Gateway and Keystone XL remain in limbo.

Railway transportation has provided a "release valve" in the short-tem, Mr. Stelmach says. Yet safety concerns in the wake of the Lac-Mégantic disaster as well as capacity issues make rail a short-term fix for a long-term challenge, he adds.

Also, concerns that the economies in Europe and China – two major sources of demand – are slowing have put downward pressure on oil prices.

Prices could remain flat or fall further, below $80 a barrel WTI, if the global economy continues to sputter, putting pressure on producers, particularly those who need higher prices to be profitable.

This macroeconomic uncertainty has prompted many investors to seek the safety of the U.S. dollar, the world's reserve currency and the global currency for oil, which further depresses energy prices, Ms. Stevenson says.

So what does the future hold?

All of these circumstances pushing oil prices down are likely to have the opposite effect sooner or later, industry observers say.

"The cliché is, the only solution for low prices is low prices," Mr. Stelmach says. "That's because oil companies have less cash flow so there's less capital to drill wells. As a result, supply declines will match with increased demand, which should lead to higher prices in the future."

So while the industry is experiencing a period of "creative destruction," the longer-term forecast is brighter, Mr. Stelmach says.

"There is a consumer demand for energy, and it may not be a question of whether there is enough oil. It's more a question of, 'At what price is that oil available to be brought to market?'"

Low prices mean tough times for all companies involved, Mr. Stelmach says. We will not, however, likely see $30-a-barrel oil anytime soon, he says. OPEC, the Organization of Petroleum Exporting Countries, would likely step in and reduce production. Still, a prolonged price drop below $80 could "squeeze marginal producers out of existence."

With that in mind, investors should gravitate to larger firms with deep pockets for the required capital expenditures to keep ahead of the production curve, he adds.

Major energy players will recover because the global economy is still relatively healthy, Ms. Stevenson says. "You can argue whether it's going to be two, three or four per cent, but the bottom line is we have economic growth," she says.

And growth requires energy.

"I don't think oil prices will go up $15 in the next six months – that's not realistic," she says. "But the bigger picture going forward is that we will have that supply-demand balance, with prices strong enough that we still get demand growth, with suppliers wanting to invest capital with the free cash flow to do it – and pay dividends to investors."

So while the sector may be down, it's just a matter of time before it gets up off the mat.

Given all the recent bad news, "the entry point looks cheap" for investors expecting a "Santa Claus rally," Mr. Larson says.

"Good names have been sold down to valuations that we haven't seen in three years," he says. "Hopefully come Christmas, you're sitting in a small profit position collecting a stable dividend."

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