In this file photo taken on Aug. 7, sections of Enbridge Inc.'s Line 3 pipeline are seen on the construction site near La Salle Lake State Park in Solway, Minn. The first new conduit from Canada's oil sands to U.S. refineries built in years began moving oil on Oct. 1, and is a big reason why one analyst is bullish on major Canadian oil sands stocks. (Photo by Kerem Yucel / AFP) (Photo by KEREM YUCEL/AFP via Getty Images)KEREM YUCEL/AFP/Getty Images
Oil and gas stocks, which had been left for dead in recent years, are enjoying a new lease on life amid surging commodities prices.
U.S. West Texas Intermediate (WTI) oil shot up to more than US$79 a barrel this week – the highest in seven years – before pulling back to the US$78-range. And the benchmark U.S. natural gas price jumped to more than US$6 per million British thermal units (mmBtu) before backing off to around US$5.75 mmBTu.
Despite the strong rally in oil and gas stocks, many energy experts are still bullish on the sector as these commodities struggle to keep up with demand in a global, post-pandemic economic recovery.
“We are in a multi-year bull market that will see oil trade at all-time highs,” says Eric Nuttall, partner and senior portfolio manager with Toronto-based NinePoint Partners LP. “Energy stocks can double or do more from here.”
These equities are cheaper than at the start of this year, says Mr. Nuttall, who runs NinePoint Energy Fund, which has mutual fund and exchange-traded fund (NNRG-NE) versions.
“I am buying names trading at 2-to 2.5-times enterprise value to cash flow versus 7- to 9-times historically. Using just US$70-oil, the average free cash flow yield is 27 per cent,” he says.
Demand for oil should grow for at least the next 15 years given that it could take decades before alternative energy sources can replace this commodity, says Mr. Nuttall, who focuses more on oil plays. “The real story is on supply.”
U.S. shale oil producers no longer have their eye on production growth as they did before the 2020 oil crash because their investors now demand share buybacks and dividends. Environmental, social and governance (ESG) investors and climate activists have forced the energy supermajors, such as Exxon Mobil Corp. XOM-N and Royal Dutch Shell PLC RDS-A-N, to let hydrocarbon production fall.
Furthermore, the Organization of Petroleum Exporting Countries and its allies (OPEC+) confirmed early this week that it plans to stick to boosting its oil output by 400,000 barrels a day each month until April 2022 instead of bowing to pressure from U.S. President Joe Biden to pour more oil onto the market.
The energy sector is on the cusp of meaningful shareholder returns with large and smaller companies returning excess cash flow through dividends and share buybacks instead of pursuing growth, Mr. Nuttall says. “That could lead to a re-rating in [stock] trading multiples from their currently depressed levels.”
He favours oil and gas producers, such as Cenovus Energy Inc. CVE-T, which should soon reach its de-leveraging target of $10-billion and announce a “significant share buyback,” and Enerplus Corp. ERF-T, which is expected to hit its debt-reduction goal by next quarter and could buy back stock, too.
Rafi Tahmazian, senior portfolio manager with Calgary-based Canoe Financial LP, is also upbeat on the energy sector. The ESG movement has helped to create a “potential energy crisis, and is creating this opportunity for us,” he says.
The OPEC+ spare capacity, which could be brought online within months to help bridge any gaps in oil supply, may not be enough to cool the markets, he says.
“We expect OPEC+ could run out of its excess capacity by the middle of next year – if not sooner. We don’t think that it is as robust as everybody thinks.”
Energy stocks are still “cheaper than even a year ago, when we called the sector a buy,” says Mr. Tahmazian, who manages Canoe Energy Portfolio Class and Canoe Energy Income Portfolio Class funds. “How can that be when some stocks, such as Paramount Resources Ltd. POU-T and Crescent Point Energy Corp. CPG-T, are up 200 per cent or more? That’s because natural gas is up from US$2 to well over US$5 per mmBTu, and oil prices are up from US$35 a barrel to the US$78-range.”
He likes energy names, such as Cenovus Energy and Headwater Exploration Inc. HWX-T, a smaller player that has exposure to the very profitable Clearwater oil play in northern Alberta, and where well costs can be recovered in less than three months, he says.
But Mr. Tahmazian has scaled back his position in natural-gas-focused stocks and instead increased his weighting in energy-service names, such as Trican Well Services Ltd. TCW-T and Secure Energy Services Inc. SES-T.
Natural gas is more of a shorter-term and volatile trade, while “oil is more of a long-term opportunity,” he says. “You can bring on gas a lot quicker than you can with oil.”
There is “very low risk in the oil and energy service stocks now,” but even with more potential risk in natural-gas names, they “will still go a lot higher if the winter is even normal,” he says.
However, “we think that there will be some pretty aggressive gas drilling this winter, and by spring you’ll see more gas supply that will alleviate the pricing – at least in North America. The global market is going to require more aggressive [liquefied natural gas] imports.”
The biggest risk is oil and gas prices climbing too high and hurting many businesses, he says. “There is nothing that will derail demand short of a massive global economic slowdown that would compare with the slowdown caused by COVID-19 in March 2020.”
Jeffrey Craig, an energy analyst with Toronto-based Veritas Investment Research Corp., is also bullish on the sector, and particularly on major Canadian oil sands companies.
With Enbridge Inc.’s ENB-T long-delayed, Line 3 replacement pipeline operating since Oct. 1 to carry oil from Edmonton to refineries in the U.S. Midwest, “that’s a big step” in helping move oil out of the country versus relying on rail, he says.
Because oil companies are not developing new projects due to a lack of increased pipeline capacity and lack of financing from banks and investors, management teams now are “forced to return capital to shareholders” after paying down debt, Mr. Craig says.
Canadian Natural Resources Ltd. CNQ-T, Cenovus Energy, Suncor Energy Inc. SU-T, and Imperial Oil Ltd. IMO-T, will have strong balance sheets by year-end, and “you could see some serious dividend increases and a lot of share buybacks,” he says.
“Canadian Natural Resources is our top pick in the space” because it has the lowest operating cost among its three peers and has a tailwind from its natural gas exposure too, says Mr. Craig, adding that he’s less bullish on Imperial Oil for valuation reasons.
These players may also benefit from the pressure on the energy supermajors to divest their Canadian oil sands assets to fund investments in renewables, he says. They could pick up assets more cheaply in what would likely be a buyers’ market.
“I have been bullish on natural gas for a while, and it’s up a lot more than oil this year, so my bullishness has played out in the current prices,” Mr. Craig says. “From here, I see more upside in oil stocks.”