The price of West Texas Intermediate crude futures surged to more than US$86 per barrel in early April from US$70 at the start of the year before pulling back slightly.Getty Images/iStockphoto
Sign up for the Globe Advisor weekly newsletter for professional financial advisors on our sign-up page. Get exclusive investment industry news and insights, the week’s top headlines, and what you and your clients need to know. For more from Globe Advisor, visit our homepage.
The rising oil price has fuelled gains in energy stocks, but investors may wonder if the rally is running out of gas.
West Texas Intermediate WTI crude futures, which surged to more than US$86 a barrel in early April from US$70 at the start of the year, have pulled back to the US$83 range.
Canadian energy fund managers argue that the oil bull market still has plenty of legs, but there may be reason for caution over the shorter term.
“We are in a supercycle of energy profitability,” says David Szybunka, senior portfolio manager and co-managing director of the energy team at Calgary-based Canoe Financial LP.
“This cycle is going to take 10 to 15 years to play out, and we’re four years into it,” says Mr. Szybunka, who manages Canoe Energy Portfolio Class and Canoe Energy Income Portfolio Class funds.
There’s little debt in the capital structure of energy companies relative to prior cycles, and “the better-quality businesses are extremely profitable,” he says.
Energy names will benefit from investors rotating from overvalued stocks into other sectors, but the commodity price doesn’t need to go up further for “us to do well on our oil stocks,” he says.
The spate of U.S. mergers and acquisitions – including a recent deal by Diamondback Energy Inc. FANG-Q to buy privately held Endeavor Energy Partners – will likely spill over into Canada, he adds.
Marriages in the oil patch could involve Canadian producers tying the knot or U.S. players doing deals amid a low Canadian dollar, he says. “But it’s always very hard to predict the timing of that.”
Money typically flows to large-cap stocks at the start of an energy cycle, but investors should start going “down cap” further in the cycle and put some chips into better-valued mid-caps, Mr. Szybunka recommends.
Among them, he finds less-risky energy royalty plays compelling. One is PraireSky Royalty Ltd. PSK-T, which gets more than 90 per cent of its revenue from heavy and light oil and natural gas liquids.
PraireSky should benefit from an acceleration in capital spending on its lands from energy companies spending more money, new start-ups, and U.S. private equity players returning to the sector, he says.
Similarly, he favours Topaz Energy Corp. TPZ-T, a royalty and infrastructure company that gets 80 per cent of its revenue from oils and liquids. PraireSky and Topaz are attractively valued, he says.
Mr. Szybunka also likes oil and gas producer Paramount Resources Ltd. POU-T, known for its Montney and Duvernay plays. Paramount’s stock trades at a steep discount to its net asset value of $40 a share, he notes.
That discount stems from a lack of awareness that it also holds land in the oil sands and the Clearwater oil play, as well as owning drill rigs and 31.5 million shares of Nuvista Energy Ltd. NVA-T, he adds.
Mr. Szybunka also favours oilfield services firm Liberty Energy Inc. LBRT-N, one of the four largest U.S. fracking firms that have 70 per cent of the domestic market. Liberty, which focuses on advanced technologies, trades attractively at less than three times cash flow.
Daniel Greenspan, senior analyst and resource team director at CIBC Asset Management Inc., agrees that the oil sector still is in a bull market, noting the last four such markets averaged 92 months.
“This one started in April 2020, so arguably we’re in the middle innings,” says Mr. Greenspan, who is co-manager of CIBC Energy Fund.
“I expect oil to trade between US$75 and US$85 a barrel this year. It’s a healthy price for the Canadian energy companies.”
Currently, there is some geopolitical risk built into the oil price, he acknowledges. That stems from supply concerns arising from Middle East tensions and tit-for-tat drone attacks between Iran and Israel.
“The outlook is still pretty good,” he says. On the demand side, interest rates are expected to fall and that should be supportive for oil demand growth in economies such as the U.S., while economic data from China is “slowly improving.”
On the supply side, “we are still seeing reasonable discipline from the [publicly listed] producers” with a focus on improving the balance sheet, shareholder returns and minimal growth, he says.
“That’s going to generate a lot of free cash flow that will go to debt repayment, buybacks and shareholder returns.”
Among large caps, Mr. Greenspan likes energy producer Cenovus Energy Inc. CVE-T. Its balance sheet is getting stronger and the company is expected to hit its $4-billion net debt target this year, he says.
When it does, “we expect increased capital returns going back to shareholders that can drive the stock to outperform,” he says.
He also favours Canadian Natural Resources Ltd. CNQ-T. It’s a high-quality business with a solid balance sheet, strong management and a record of delivering on its operations, he says.
It’s one of the first names that will attract generalist fund investors who want exposure to the Canadian energy space, he adds.
Among mid-caps, Mr. Greenspan likes Crescent Point Energy Corp. CPG-T, which focuses on light oil production and is a “value opportunity.”
Crescent Point, which will seek shareholder approval on May 10 to change its name to Veren Inc., is paying down debt, increasing shareholder returns and executing on its drilling program, he says.
Curtis Gillis, vice-president and research lead for equities at Toronto-based CI Global Asset Management, is also positive on the oil sector for the longer term because he sees supply unable to keep up with demand.
However, he has turned cautious in the shorter term because he doesn’t expect the oil price to climb much beyond recent highs.
“I have taken a bit of oil exposure out of my energy and Canadian equity funds,” says Mr. Gillis, portfolio manager for CI Global Energy Corporate Class Fund and CI Canadian Investment Fund.
The price of oil could still move higher this summer due to strong driving demand or geopolitical risk, but “we see it coming down in the fall,” he says.
A lot depends on what Saudi Arabia – the world’s biggest crude exporter – will do at the June 1 meeting of the Organization of Petroleum Exporting Countries (OPEC), he says.
“We expect some of [OPEC’s] voluntary cuts will come back into the market in the second half of the year. In 2025, the oil price is more likely to be softer in the US$70- to US$80-a-barrel range,” Mr. Gillis says.
If there are supply disruptions in the Middle East, OPEC still has more than five million barrels of spare capacity that should “absorb any surprise shortfalls that are transitory,” he adds.
Among global oil names, he likes BP PLC ADR BPN-N because of its attractive valuation relative to its peers and diversification into biofuels within the renewable energy space.
There’s less competition in biofuels versus the solar and wind power industries, he says, and biofuel transportation can rely on existing infrastructure such as pipes and gas stations.
He also likes Italian oilfield services firm Saipem S.p.A. SAPMF. It has exposure to Middle East oil and is involved in offshore drilling, where there’s less competition after consolidation in this market.
Mr. Gillis has also been adding to Aes Corp. AES-N, a U.S. operator of renewable energy power plants. “It is one of the biggest providers of power for cloud data centres,” he says.
As he trimmed his oil exposure, he has been boosting his energy fund’s renewable energy and utility weighting to more than 20 per cent from 5 to 8 per cent in 2022.
These companies should benefit from future interest rate cuts since they often depend on debt financing, he says.
“We are energy agnostic,” Mr. Gillis says, referring to his energy fund’s holdings beyond fossil-fuel stocks. “We just saw better valuations in some of the renewable names.”
For more from Globe Advisor, visit our homepage.