PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF) announced today that it hit its production target for 2012. The company averaged 53,200 barrels of oil equivalent per day, a 16 percent boost from last year’s tally excluding planned dispositions. More than 90 percent of that was oil and liquids.

That’s encouraging news for a company that has often had trouble matching the lofty expectations from its initial public offering back in late 2009.

The bad news–and the reason for selling in the stock this morning–is management announced a capital budget for 2013 of CAD675 million, sharply lower than last year’s.

That’s still good enough for PetroBakken to reach respectable 8 percent to 12 percent production growth for the full year. Decline rates are projected to be in line with last year, and development is proceeding at the company’s Bakken and Cardium shale properties as well as from conventional wells in Saskatchewan.

Exit production rates for 2013, however, are now projected to be roughly flat. Although 71 percent of capital spending will be directed to drilling, completion and tie-in activities, 29 percent will be spent on much more conservative activities to boost efficiency. Management also states it will hedge prices for approximately 25 percent of output.

Because it can still grow and develop spending less money, this capital plan doesn’t diminish PetroBakken’s long-run ability to build wealth for shareholders. It also ensures the balance sheet will be able to fund the dividend and pay off some high-cost debt this year.

The late 2012 conversion of former parent Petrobank Energy & Resources Ltd’s (TSX: PBG, OTC: PBEGF) ownership stake into ordinary PetroBakken shares is also a plus. Mainly, it dramatically improves the visibility of the company’s ownership and capital structures and eliminates the long-standing overhang of uncertainty about just what Petrobank would eventually do with its PetroBakken shares. That’s no longer an issue.

The budget does, however, reflect a much more conservative spending plan than in 2012. And that’s almost surely due in large part to the exploding spread–or “differential”–between the price of Canadian oil and that of West Texas Intermediate (WTI) crude, the benchmark price for North America.

Differentials Downer

For some time WTI has itself been priced well below Brent crude, the global benchmark for oil. The Canada differential has traditionally existed for much the same reason, i.e. greater distance away from the epicenters of demand. Over the past year or so, however, we’ve seen some extremes reached, as output has ramped up across North America and put a premium on means of transport.

Differentials are a major incentive for producers to ink major infrastructure deals with midstream companies. The result is boom times for builders of pipelines and well as companies skilled in rail logistics.

And Canadian Edge Aggressive Holding Parkland Fuel Corp’s (TSX: PKI, OTC: PKIUF) acquisition of such operations from AvenEx Energy Corp (TSX: AVF, OTC: AVNDF) last month promises to be a huge positive for its earnings going forward. Parkland is now a buy on dips to USD18 or lower because of it.

Sooner or later these incentives will create enough infrastructure to dramatically reduce price differentials between Canadian oil and WTI crude. For now, however, they’re substantial and a threat to Canadian oil producers’ near-term profitability, even as the price of natural gas and natural gas liquids (NGL) have weakened in the mild winter.

Viewed in this light, PetroBakken’s move to curtail 2013 capital spending is very understandable. The selling following the announcement is also understandable, and pretty much the same Bay Street reaction as we’ve seen to other companies that have scaled back plans.

The bottom line, however, is PetroBakken’s profitability should still be high enough to support continued long-run development, a strong balance sheet and the dividend. That’s also a somewhat better prognosis than what we heard from Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE) earlier in the week.

That company, which PetroBakken replaced in the CE Portfolio last year, announced a capital plan with “flat to modestly below” 2012 exit rate production, though its management affirmed the safety of its dividend.

It’s pretty clear, however, that Canadian price differentials will be a significant headwind to Canadian oil producer earnings and share prices at least for the first half of 2013.

In fact, Canadian energy producers and related companies right now are by far the most challenged sector represented in the CE Portfolio.

Already Conservative

The demise of Poseidon Concepts Corp (TSX: PSN, OTC: POOSF) last month is part and parcel of the challenge posed by price differentials and the pared-back drilling we’ve seen. And given the dividend cuts we saw last year in the face of weaker gas prices, it’s only natural to ask if we’re not too exposed to further weakness in Canadian oil.

If you’re a very conservative investor who has really loaded up on energy stocks, this is another good reason to move to a long-term strategy of portfolio balance. But at least for now I’m comfortable sticking with the positions we have, including PetroBakken.

First, although producers are a significant Canadian Edge Portfolio piece, they’re right now just five positions out of nearly 40. A further haircut in the sector won’t kill us–any more than last year’s retreat did, as the overall Portfolio still finished the year up about 7 percent despite some big losers.

Second, energy is the most dynamic sector in Canada for the long haul, and there are huge values as companies drill into shale. Every one of our holdings is cheap, well capitalized, superbly positioned to boost production over the long term and a potential takeover target as well, despite current price weakness.

Third, over the past several years I’ve retreated into the sector’s strongest. As I pointed out in the January Portfolio Update, PetroBakken is the most aggressive by far among our producer picks. And today’s announcement doesn’t do anything to change that assessment. But it no way diminishes the company’s long-run promise, and I’m not inclined to sell into current weakness.

As for the rest of our energy holdings, ARC Resources Ltd (TSX: ARX, OTC: AETUF), Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF), Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) and Vermilion Energy Inc (TSX: VET, OTC: VEMTF) are about the most conservative the sector has to offer. Vermilion’s recent dividend increase is the most positive sign it could give us right now.

Even these stocks will get hit more this year if energy prices fall enough and differentials stay where they are now, by some estimates more than USD30 a barrel.

But no diversified portfolio in Canada can be without this sector. And once there is a turn–and there will be–history shows upside will be truly explosive and fast.

Here’s when Canadian Edge Portfolio Holdings will report their next sets of numbers. Dates are described as “confirmed” if companies have already announced release dates or “estimate” if we’re making a forecast based on past practice.

Conservative Holdings

• AltaGas Ltd (TSX: ALA, OTC: ATGFF)–March 8 (estimate)
• Artis REIT (TSX: AX-U, OTC: ARESF)–Feb. 28 (confirmed)
• Atlantic Power Corp (TSX: ATP, NYSE: AT)–Feb. 28 (estimate)
• Bird Construction Inc (TSX: BDT, OTC: BIRDF)–March 7 (estimate)
• Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF)–March 12 (estimate)
• Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF)–Feb. 13 (estimate)
• Canadian Apartment Properties REIT (TSX: CAR, OTC: CDPYF)–Feb. 28 (estimate)
• Cineplex Inc (TSX: CGX, OTC: CPXGF)–Feb. 8 (estimate)
• Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)–March 6 (estimate)
• Dundee REIT (TSX: D-U, OTC: DRETF)–Feb. 22 (estimate)
• EnerCare Inc (TSX: ECI, OTC: CSUWF)–Feb. 22 (estimate)
• Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)–March 21 (estimate)
• Keyera Corp (TSX: KEY, OTC: KEYUF)–Feb. 15 (estimate)
• Northern Property REIT (TSX: NPR, OTC: NPRUF)–March 13 (estimate)
• Pembina Pipeline Corp (TSX: PPL, NYSE: PBA)–Feb. 15 (estimate)
• RioCan REIT (TSX: REI, OTC: RIOCF)–Feb. 14 (estimate)
• Shaw Communications Inc (TSX: SJR/A. NYSE: SJR)–Jan. 10 Flash Alert
• Student Transportation Inc (TSX: STB, NSDQ: STB)–Feb. 13 (estimate)
• TransForce Inc (TSX: TFI, OTC: TFIFF)–Feb. 28 (estimate)

Aggressive Holdings

• Acadian Timber Corp (TSX: ADN OTC: ACAZF)–Feb. 6 (estimate)
• Ag Growth International Inc (TSX: AFN, OTC: AGGZF)–March 14 (estimate)
• ARC Resources Ltd (TSX: ARX, OTC: AETUF)–Feb. 8 (estimate)
• Chemtrade Logistics Income Fund (TSX: CHE, OTC: CGIFF)–Feb. 22 (estimate)
• Colabor Group Inc (TSX: GCL, OTC: COLFF)–March 22 (estimate)
• Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)–March 15 (estimate)
• Extendicare Inc (TSX: EXE, OTC: EXETF)–March 1 (estimate)
• IBI Group Inc (TSX: IBG, OTC: IBIBF)–March 26 (estimate)
• Just Energy Group Inc (TSX: JE, NYSE: JE)–Feb. 8 (estimate)
• Newalta Corp (TSX: NAL, OTC: NWLTF)–Feb. 15 (estimate)
• Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–Feb. 14 (estimate)
• Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–March 7 (estimate)
• PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–March 7 (estimate)
• Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–March 7 (estimate)
• Vermilion Energy Inc (TSX: VET, OTC: VEMTF)–March 5 (estimate)
• Wajax Corp (TSX: WJX, OTC: WJXFF)–March 6 (estimate)