World stocks are off and running in 2024′s beautiful bull market, kicking off what I told you should be a good-to-great year. But energy stocks haven’t been so energetic – which partly explains the TSX’s soft start. That should change. A shift from laggard to leader for energy will likely be among 2024′s biggest positive shocks. Let me explain.
Energy humiliated its many cheerleaders last year, falling 0.2 per cent globally while world stocks soared 20.5 per cent. Canada’s big energy sector broadly trailed the TSX, contributing to the index’s lacklustre 11.8-per-cent returns. Few expected that. After energy outperformed in 2022, riding the wave of high oil prices as Russia invaded Ukraine, many predicted that a 1970s-style decade of supply shortages and a recovering post-COVID China would spike oil prices anew and light a fire under energy stocks.
My February, 2023, column rejected that narrative, showing how oil prices had quietly fallen by over a third from March, 2022′s high. Global production obliterated shortage fears and looked set to keep rising in places such as Norway, Guyana and North America, where combined Canadian and U.S. oil rig counts jumped. U.S. President Joe Biden’s temporary ban on new leases on federal lands didn’t bite – in fact, U.S. output actually topped record highs. Hence, high and rising production globally capped oil prices. While that provided some good news for inflation-fatigued Canadians, it was bad news for energy firms, whose profits rise and fall with crude price fluctuations. Production boomed and crude prices waffled between about US$70 and US$95 per barrel, but energy stocks lagged behind global stocks.
Now everyone extrapolates this weakness continuing throughout 2024. Fund flows, fund manager surveys and valuations all point to investors slashing energy holdings. But this shift to sour sentiment underrates the fundamentals. Oil prices should rise later this year, refuelling profits for energy stocks. These and British Columbia’s works-in-progress – think LNG Canada and Woodfibre LNG – will double North American LNG export capacity later this decade.
No, this is about simple incentives and normal market behaviour. When energy firms saw higher prices, they beefed up production to capitalize. Now? Well … they’re beefed up and beefed-out. U.S. producers are completing wells faster than they are drilling new ones, running down America’s “fracklog” of drilled-but-uncompleted wells. That dwindling fracklog is down 18 per cent year over year, which means less inventory is available to come online quickly. The low-hanging fruit has been picked.
Producers aren’t replacing it. Discouraged by rangebound prices and higher borrowing costs, oil producers got lean. Now, after years of consolidation – overextended wildcatters couldn’t keep servicing debt whenever prices were down – the mega-drillers are in charge. With their more judicious production targets reigning, U.S. rig counts fell from 621 at the start of last year to 497 as of Feb. 16. U.S. drilled wells are down 17.8 per cent year over year through December, 2023. Given production typically lags drilled wells by about six months, expect overall production to slow significantly. That should outweigh an expected 8-per-cent uptick in Canadian drilling.
Meanwhile, oil demand is vastly underestimated, despite global pockets of economic weakness in Germany, Britain and China. The eurozone’s better-than-feared economy plus solid U.S. GDP growth means the world will be buying more oil than analysts now expect.
Hence, oil prices should climb. Not sky-high, but toward the upper end of 2023′s range, boosting energy sector earnings and the TSX. Many wrongly see booming production as bullish for energy and cutbacks as bearish. But the opposite is true. Booms usually mean low prices and vice versa. Oil price, not production volume, drives profits and oil stocks. It tells you when and whether companies will recoup high drilling and exploration costs. Higher oil prices, married with cost-consciousness, should produce an earnings bonanza.
While this should help the TSX overall, Canadian companies may benefit less than America’s. Huge U.S. oil companies sport strong balance sheets, low-cost production and integrated business models, allowing them to capitalize best when oil prices rise, but don’t skyrocket. Yes, the Trans Mountain pipeline’s ramping-up may cut the discount on Alberta’s oil, but it likely doesn’t eliminate it – and if Canada’s output rises, transport issues could resurge and choke off some of the potential supply from the oil patch.
“But won’t pricey oil fan high gas prices – and reignite Canadian inflation?” you may ask. Perhaps temporarily, to an extent. But last year’s global economic resilience and robust stock returns show you they are just one factor among many – not make-or-break.
So enjoy this bull market. And anticipate energy stocks helping out later in 2024.
Ken Fisher is the founder, executive chairman and co-chief investment officer of Fisher Investments.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.