Bullish on Oil: An Interview with Eric Nuttall
This week our guest is Eric Nuttall, Partner, and Senior Portfolio Manager at Ninepoint Partners LP. Eric manages the Ninepoint Energy Fund (NNRG) and the Ninepoint Energy Income Fund (NRGI), which are traded on the NEO Exchange. The Ninepoint Energy Funds are some of the largest actively managed energy funds in the world. Eric’s views on oil and gas commodities and equities are sought after by the media and investors.
Here are some of the questions Peter and Jackie asked Eric: Are you still an oil bull? Do you think oil markets could rally in the second half of 2023? What is your view on longer-term oil market fundamentals? At current oil prices, how are oil and gas equities performing? Are institutional investors still avoiding oil and gas equities? With oil and gas equities at relatively low valuations, should we expect foreign takeovers? Why are Canadian oil and gas companies valued less than their US peers? Does Canadian federal policy, like the cap on oil and gas emissions, impact the valuations of Canadian producers?
Content referenced in this podcast:
- Eric Nuttall’s recent webinar “What does a possible recession mean for the oil trade?” (April 12, 2023)
- Trans Mountain Pipeline Interim Tolls (June 2023)
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Episode 205 transcript.
Disclosure:
The information and opinions presented in this ARC Energy Ideas podcast are provided for informational purposes only and are subject to the disclaimer link in the show notes.
Announcer:
This is the ARC Energy Ideas podcast with Peter Tertzakian and Jackie Forrest. Exploring trends that influence the energy business.
Jackie Forrest:
Welcome to the ARC Energy Ideas podcast. I’m Jackie Forrest.
Peter Tertzakian:
I’m Peter Tertzakian. And welcome back. So Jackie, what are we going to talk about today? I think we’re going to talk about oil and some of the things that are going on there, but one of the big things about Canadian oil is that infamous pipeline, Trans Mountain Pipeline, otherwise known as TMX. What do you think?
Jackie Forrest:
Well, yeah, so the TMX tolls came out, I think it’s going to be ready to start by the end of the year and start in the new year. But the tolls came out. They’re interim tolls because it’s only 80% complete. So as a reminder, this project was supposed to be $7.4 billion, and now it looks like $31 billion. And it may even be more money. I’m not a 100% sure, but assuming it stays at $31 billion, the tolls are very high. I guess it isn’t a surprise, but if you’re a committed shipper, and by the way, committed shippers made commitments back in 2012 and they didn’t know the price of the tolls, but it’s $8 USD if you’re an uncommitted shipper, about 20% of the volume is not firm with tolls.
Peter Tertzakian:
So let’s just back up for a second. We’re talking about the cost to a shipper to take a barrel of oil from the Edmonton-Harvesty area all the way to the terminal, which is in Burnaby.
Jackie Forrest:
Yes, that’s right. And that doesn’t include the marine costs, which are even going to add additional costs.
Peter Tertzakian:
So let’s just call it $10. What’s a typical, if you wanted to get it from Edmonton to say the Gulf Coast of Texas?
Jackie Forrest:
Well, it’s probably not far off that, but you’re going a lot further. And the thing about this is when we consider that the project has basically gone up more than threefold here.
Peter Tertzakian:
Four.
Jackie Forrest:
Four, yeah, that’s right. More than four times. It’s not surprising. The tolls are high. These tolls are about double what I would’ve expected, and I’m sure what most shippers expected when they signed on to these in 2012. So it’s disappointing in that you’re going to be paying a lot more to get your crude to market. It was viewed that you were going to be getting a premium price. I think this toll is taking most of that away. And of course, because the project costs so much, it’s not going to provide a great return to investors either. So to me, it’s an example of why we need to fix this regulatory system that we have, that projects take well over a decade to construct and have so much project scope creep that we end up in this situation.
Peter Tertzakian:
I mean, microscopic regulatory issues that just drove the cost of this thing through the roof. So let’s get someone knowledgeable about that. But in the meantime, we still need to talk about oil.
Jackie Forrest:
That’s right.
Peter Tertzakian:
So we are delighted to have back a special guest whose last time we had him was in September of… When was it? 2019. We’re absolutely delighted to have Eric Nuttall. He is a partner and senior portfolio manager with Ninepoint Partners LP in Toronto.
Eric Nuttall:
Great to be with you again. I can’t believe it’s been four years.
Jackie Forrest:
Yeah, lots have happened. We were just saying the price of oil was $58 when you were on the podcast last time. Today, right now around $67 at the time of recording. So up $10, but it’s taken a lot of zigs and zags since then, down to zero at one point, up to over a hundred dollars at another. So you’ve been on quite a rollercoaster since we last talked to you.
Peter Tertzakian:
But before you get going, Eric, I know as I said, you don’t need a lot of introduction as an uber investor in the Canadian oil and gas sector, but for those in the audience that are not familiar with you, why don’t you just give us a thumbnail of who you are and what you do and how you got there?
Eric Nuttall:
You bet. I started my career in 2003 at Sprott Asset Management and was involved when we launched the Sprott Energy Fund in 2005. So that was my beginning. We did a management buyout from Sprott in 2017 to become Ninepoint Partners. The fund itself remained in the same state, so I’ve been managing that since about 2010. So it’s been some highs, a lot of lows, a lot of wisdom gained throughout that time. So now assets sit at about $2 billion split between the Ninepoint Energy Fund and then an income fund that we run as well. So the Ninepoint Energy Fund. Now, the last time I checked was the third largest actively managed energy fund in the world, and our focus today is solely on Canadian oil and gas companies.
Peter Tertzakian:
Right. I mean, I think I’ve known you, Eric, since the early two 2000s. And what got you focused on oil and gas equities in your background?
Eric Nuttall:
It was purely by chance. Yeah, purely by chance, the person that hired me, at Sprott was, excited about natural gas at the time. I think we were soon to trade to $7 or $8. And so he wanted somebody to analyze natural gas companies, and that gave me in.
Jackie Forrest:
And Eric, maybe not of everyone knows, but someone just showed me the other day that I can track your Ninepoint energy fund on my phone. So just a little bit about how people can find the fund.
Eric Nuttall:
So we’re listed on NEO Exchange. The main fund is NNRG, and then my income fund is NRGI. And so that’s an easy way to gain access, I’ve got on my iPhone, and so when I’m on vacation or whatnot, I can easily see how I’m doing or not doing.
Jackie Forrest:
Down 2% today I see.
Peter Tertzakian:
Well, you’re supposed to turn your phone off on vacation.
Eric Nuttall:
Right?
Peter Tertzakian:
Well, shall we get into it, Jackie?
Jackie Forrest:
Yeah, for sure. Well, let’s talk. I know you’ve been an oil bull for quite a while, and of course, you’ve ridden the upward swing that happened after the invasion of Ukraine, but now oil prices are down quite a bit and surprisingly it did not move very much. In fact, it’s down a little bit from before OPEC, actually, Saudi, announced a 1 million barrel day cut about a week ago. So are you still an oil bull? And maybe explain why you think that the price of oil didn’t move much with this Saudi cut.
Eric Nuttall:
I am, and to be an oil bull, it’s even rarer than being an energy fund manager. You’ve got Goldman Sachs supposedly throwing in the towel, cutting their price forecast, et cetera. When I reflect on, okay, why am I bullish? It really comes down to four main things. One is, I believe demand, even current and medium and long term will be stronger for longer than most people believe. I just think the energy transition that we’re supposedly on is going to take much, much longer than the average people believe. It was common during COVID. People were talking about the new normal and peak demand and such, and I just don’t think that’s based in reality.
But what makes me bullish is on supply. We’ve had to deal over my career with the rise of US shale, a massive, massive destabilizing force. We very confidently believe the best days of shale are behind us. Growth rates are going to be a fraction of what they once were. We looked to OPEC. I got to visit with the Energy Minister in Riyadh in January of this year, which was just an incredible conversation. But going into that meeting and coming out, we believe that OPEC, when you adjust for short-term curtailments, we’re running out of productive capacity just due to that lack of ability to invest during very low oil prices. We feel very good about that now.
And then lastly, the supermajors due to ESG and divestments, policy uncertainty from governments with windfall taxes, concerns about long-term demand growth, et cetera, just prevent them from being able to invest sufficiently as well. So it’s the culmination of those four things. I reflect on the past year, and it feels like it’s been energy investors up against the US President with the release of the SPR under the false pretense that we were going to lose 3 million barrels per day.
So I think that’s distorted the market’s ability to see how tight things are when you adjust for that. Yes, we’ve had some disappointments such as Russian production, and Chinese demand not being as robust, but is that weak demand or is it just our expectations were too high? And we still see record imports record demand for the past several months, et cetera. And so I just think people, we’re in this state where energy investors have been disappointed and they just don’t want to be hurt again. And so they’re going to have to see it to believe it. They’re going to have to see inventory draws. They’re going to have to see that follow through on price before sentiment can come back. It’s amazing. You can measure this in several different ways, but my own feeling is sentiment today is as bad as it was during the lows of COVID, which to me is astounding.
Peter Tertzakian:
Right. So actually just as a side note for our audience, the SPR, which you referred to as the strategic petroleum reserve, and that is this storage caverns that are drawn under certain circumstances, geopolitical or otherwise. And so the Biden administration did a release as a consequence of the high oil prices. And so I want to come back to that. But before we do that, let’s go to the first conjecture, which I believe, is that demand is going to be stronger for longer. However, in the near term, there are all these recessionary expectations and there’s a very strong correlation between economic activity and oil consumption. You posted a podcast, which Jackie I think will put in the show notes, can you believe in a recession and be bullish on oil at the same time? So maybe first of all, give us the answer to the question, but do you view recessionary forces as a short term and that you’re talking about being bullish longer term and whatever that longer-term time horizon is? Is it a year, is it two years or what are we talking about?
Eric Nuttall:
Yeah, so the reason I did that podcast is that it was since June of last year. That’s when the courtesy of the Federal Reserve’s sharpest hiking in history and really the concerns that that will eventually trickle through to the US and European economy, maybe globally. And this concern about always fighting this boogeyman of what might be in the coming months and quarters. And we know this is the most talked about recession in history. And so I wanted to freeze, well, let’s just go there. Let’s believe in the recession because every economist on the planet seems to, and then what does that mean for oil demand? And taking a step back, we’re a student of following oil inventories because there are so many different things you can look at, but historically, inventories to price have held very, very strong. So if you can figure out where inventories are going, you can figure out where prices should go at least.
And so coming into this year, we were at a very significant deficit relative to normal even after that strategic petroleum reserve release. And so that when you’re starting at a situation of undersupply, we all suffer from recency bias, meaning that the most recent experience is freshness in our mindsets, the filter through which we see the world. And so the last recession we all know is 2020 COVID, the biggest demand shock in history. Prior to that great Financial Crisis, we were hours away from the financial system ceasing to exist. But recessions prior to that, which I think most mainstream economists, not the perennial doomsayers, but there’s the average economist would say, we’re going to experience a normal kind of slowdown. And in prior recessions like those, what fell was not oil demand. What fell was the rate of growth in oil demand. And what’s special this year, and we can debate whether it’s disappointing or not, is the pace of normalization within China, specifically aviation and road traffic, both of which are very, very strong.
What’s new this year relative to others is you’ve got an underpinning of non-OECD growth, which is where total global demand growth has come from over the past 20 years. I think it’s in fact like 106% of demand growth for the past 20 years has been non-OECD. And so we get access to an army of consultants and analysts and whatnot. We reference one firm of a firm called Energy Aspects, they would be globally recognized. And so we use their work and they do model recession in the United States and Europe and having demand fall, which is very rare. But when you consider demand growth elsewhere in the world plus China’s normalization, the result is we should end this year at least a five-year low in terms of inventory levels. And that situation of undersupply should persist next year.
And that’s with the recession, with demand destruction, which we very clearly are not seeing. When you look at the demand for flights, when you look at diesel gasoline demand up one to 3% in the United States as of a week ago, you’re yet to see any chinks in the armor of the demand growth story. And yet we’re in this situation where I call it price setting narrative. The price of oil falls. Everyone has heard about recession, recession, recession for almost a year now. And so you look at the price and you say, “Aha, that must mean the demand is weak.” Even though categorically we can show and demonstrate the demand so far this year is running well ahead of people’s expectations.
Jackie Forrest:
Yeah, no, I would agree with you in that a recession, we could still have a tight market, especially because we got support from OPEC as well in that scenario. So based on that and based on how the markets reacted to this Saudi cut, do you still buy into this second half of the 2023 oil rally story? I know Goldman Sachs, you just mentioned it earlier, they cut their oil price today.
Eric Nuttall:
Yeah, so they cut their year-end target to only $80. We’re trading 67, 68. Oh my gosh, what a horrible environment. Sentiment’s awful. Sentiment sucks right now. You can measure that in net length in WTI contracts. You can measure it just last week when we had an erroneous article suggesting some settlement between the United States and Iran that would allow for exports of up to a million barrels per day. And oil fell, I think by as much as $4 intraday. And then you reflect on, well, geez, Iranian exports right now are 1.4 million, so the barrels are already flowing. And that price move from a false story was more than the most powerful person in the world, the Saudi Energy Minister, announcing a voluntary 1 million barrel pretty cut effective in a month that I think will persist through the end of this year until they get what they want. And you have to understand the intent behind that cut.
And so it just shows you how poor sentiment is. The underpinning of my second-half thesis is inventory draws. You’ve got seasonality, you’ve got China, and you’ve got persistent strong demand still from the United States despite these recessionary fears. We’re looking for absolutely massive stock draws in July and August. And again, historically, this relationship has broken down somewhat, but at least historically as inventories fall, that sends a price signal to oil and sends a meaningful upward trajectory. If you account for SPRs, that’s strategic petroleum reserves, take those out of current levels, the fundamental price for oil should be in excess of a hundred dollars using historical relationships. So you can already argue that oil is mispriced. The SPR release has completely distorted the market’s ability to see things as we think we see them. And so our belief is the massive magnitude of draws should send oil higher into year-end.
Peter Tertzakian:
Yeah. I want to focus on a couple of things that you said. First of all, a point that you made, which I want our audience to be… I want it to be reinforced, and that is that oil demand is going to grow year over year. The recession and whatever you believe about the recession only affect the rate of growth. So we’re only debating how much oil consumption is going to grow. And that speaks to resilience on the demand side, which you argue is already priced into the market.
So I want to shift to the other side of the market, which is supply, and key on this word that you use called sentiment because, in basic financial theory, price embodies the collective wisdom of the entire market. In other words, all the traders in the world were trading this thing and they distill the information much as you do, and the collective average of everybody in the market, buyers and sellers, come up with this thing called price. And so what is it about that price that is weaker than it was, it’s been softening, that is distortionary or causing poor sentiment as you call it? So if it’s not the demand side, then what is it about the supply side theory that is weak? And specifically, I want to bring up the issue of whether is there more oil leaking into the market from Russia in these shadowy markets and Iran than we are accounting for. Is that one of the issues?
Eric Nuttall:
It’s a very excellent question, and I think it goes back to why I believe and many believe that there is this chasm between the two markets for oil. And so there’s the physical market for oil, which we would peg demand now at about 102 million barrels per day. Then there is the paper market or the financial market for oil. So all of the contracts and derivatives at such are traded on a daily basis, and that’s approximately 30 times bigger than the physical market, despite oil being the largest commodity in the world.
I’ll share some observations from people that I’ve chatted with in recent days where they talk to physical crew traders down in Houston, and this will go against, the price currently. But generally speaking, what they tell me is that physical oil traders are incredibly bullish right now given the underlying strong demand, immature draws, et cetera.
Contrast that to accounts and funds and CTAs and algorithms and such, the trade-off of different things, again, recessionary expectations, the financialization of oil, you express that negative view by shorting oil, et cetera. And so that pool of money, unfortunately, is much, much bigger than what the physical traders have access to, especially after a very challenging year. This year was some over the more notable crew traders down 40-odd percent. Well, that reduces the amount of money you can put to work and reduces the number of players on the field. And so you can have these periods of distortion between those two markets. Again, the energy minister talked about this just this past weekend, in an interview on CNBC at some conference. And so ultimately you need a shock to narrow the chasm between those two. So you can have a weak price short term based upon a false narrative, even though fundamentals remain strong and ultimately the proof will be shown in inventories.
Regarding your question on supply, I think supply has disappointed. Very clearly Russian production and Russian exports have remained much stronger than people thought. Ignore the IEA last year saying, “Oh my gosh, we could lose 3 million barrels per day.” And that was the pretense under which Biden was allowed to release barrels from the SPR. As of March of this year. Russian exports hit an all-time high, even with sanctions, even with a boycott from civilized nations, et cetera. And when you look at some countries in the world, I’ll make this up, but you’ll get my point, like Morocco where oil production is magically up 300%. Well, where are those barrels coming from? It’s very clearly Russian barrels that are finding themselves through the market.
So you have Russia production holding steady up until recently, I recently met with Rystad, an oil and analyst Energy Aspects, and then Sanford Bernstein, all of whom I think do very good work. And they all believe that Russian net exports have now finally fallen by about five to 700,000 barrels per day just in the last few weeks. At the last OPEC meeting, this wasn’t properly reported, but Russia agreed to use third-party estimators in terms of production, abide by those, and also offer penalty cuts later on.
So that we’ve had to fight that narrative, plus I think us frankly just hasn’t been strongly enforcing their sanctions on Iran. Iranian exports hit a recent high month. So yes, I would say the supply is a little higher than what we thought. We’ve yet to see that in inventory draws. And so ultimately it comes down to the improvement in demand, both from seasonality and China and elsewhere, overwhelming some stronger supply than what we would’ve thought.
Jackie Forrest:
Eric, how much do electric cars do you think factor into the sentiment? I mean, when we met last time in 2019, EVs were 3% of new car sales. The IEA expects globally this year, more than 18% of new car sales will be electric vehicles. This whole get off fossil fuels, the end of fossil fuel, do you think that is factoring into sentiment as well?
Eric Nuttall:
It doesn’t help. I actually think people are more informed today than they were when we last spoke. I think there’s a growing recognition that the extremely aggressive government targets for EV penetration are going to be deferred somewhat, whether it’s copper availability or funding or lack of charges or whatnot. And Peter’s probably a better person than I to speak to a lot of those particular details, but I find people are more informed now than they were three or four years ago. They know that gasoline is roughly 27% of total oil demand, where four years ago, the average person probably would’ve thought it was 90 to 95%. And you hear about governments wanting to mandate EVs and banning plastic straws, and it was feeding this narrative that peak demand was right around the corner, which I think most people now are much, much more informed.
Peter Tertzakian:
Yeah, I think there’s a greater awareness that the gasoline demand side of it is not just looking at how many EVs are being sold in the penetration rate. It’s much more a function of how many combustion engine vehicles are being taken off the market, which is a lot slower than the EV sales growth. So you got to look at both sides. Okay, fine, EVs are growing, but how many people are actually ditching their combustion vehicles around the world? That’s a whole other discussion that Jackie, you, and I have had, and we’ll probably have many times more.
But let’s switch to the sentiment of equities that are the sentiment of oil price and natural gas price. But let’s look at the sentiment of the equities themselves. Are they still trading cheaply? And what are the institutional investors thinking about cash yields, et cetera?
Eric Nuttall:
So let’s start with the sentiment. So I can measure that in a few ways. I can measure it through inflows versus outflows, just the collective emotion and sentiment of I’ve done a ton of marketing this year across the country, back and forth, meeting with advisors all across the country. And I would say people are optimistic, but they’re exhausted. My fund is probably down roughly 8% on the year, and it feels like I’m down like 50 because the volatility has just been just an absolute brutal killer where you can have days today where you’re down three or $4, and seemingly other than a Goldman downgrade where it’s only $80 by the end of this year, you really can’t explain it. And so I think that volatility is slowly eroding people’s conviction where you’re in a state now where you really have to believe it to see it. We have to see Russian experts truly fall. We have to see the inventory build, we have to see demand hold in, et cetera.
And so yeah, I would say sentiment today is challenged. From a valuation perspective, what keeps us very, very excited about the space are two things. Valuations combined with a catalyst to driver rereading. And so of my holdings, I would estimate they’re discounting on an oil price of about $55 to $58 oil long-term. You can measure it from free cashflow yields like at the current oil price, we have the sector trading at about 11% free cashflow yield next year, or the ability to return 11% in the form of buybacks and dividends. So that’s our starting case. And when I talk about catalysts, it’s the commitment of the sector to maintain a low to no growth strategy to allow them to maximize free cash and use that to use free cash flow in very, very meaningful buybacks.
Our pitch to boards has been we do not need a generalist investor to care ever again about this sector and still have stocks go up meaningfully by and from current levels. We’re talking well more than a hundred percent we believe. So long as boards say, “If you don’t see the value in our stock, we do, and we’ll use every nickel of free cash that’ll buy back from you.” Because we have examples where let’s say at $80 oil companies could privatize themselves at a free cash flow with four years of free cash, and I’m getting 30 years of reserves, production cash flow, and free cash flow dividends for free. So that’s what is still exciting to me despite the volatility in days like today where you’ve just got to bear the mental anguish believing in much stronger days in the coming weeks and months.
Jackie Forrest:
So Eric, we had talked in 2019 about the fact not a lot of institutional investors were in the space, I think you had said it some days, just a few people like yourself and maybe one other buying stocks for Canadian oil and gas. But lots has changed. As you say, the yields are really good now they’ve proven over the last few years, at least the last year, that these companies can provide yields. I think the long-term outlook for oil and gas, a lot of people do sort of look at this and say, “Hey, this looks like underinvestment.” So many more compelling fundamentals. Have you seen more institutional investors or even generalist investors come back into the space? I mean, the multiples don’t really reflect too much more interest, but.
Eric Nuttall:
So I’ll use myself as a proxy. So we typically have only been a retail fund. We had our first institution come on board last year. We have several prospects currently and mainly from the US, which was surprising to us, not yet from Europe. I still think the concerns around ESG and divestments and tar sands and all of that nonsense are preventing European funds flow for now. But I do think institutional interest is there and increasing. But again, going back we can’t have the volatility as we have now. You can’t as an institution deploy, then fall 15% in a month off of sentiment. So I just think we need to baseline and stabilize. There’s a lot of interest, but that is not yet translating into funds flow because of the volatility in the oil price
Peter Tertzakian:
In your travels and speaking with oil and gas companies, we’ve spoken about yields and buybacks, and dividends, but historically oil and gas companies have to put the money back in the ground to maintain production. So what is the directive from investors to companies here in Canada and also to place prolific places like the Permian in the US?
Eric Nuttall:
So again, we would be one of the larger investors in Canada and the very polite but forceful commentary that we have with our company CEOs and boards is, energy investors need to be paid for the misery of the worst bear market in history over the past 10 years, and we’re going to get rewarded for that through meaningful buybacks. Dividends, but our preference is buybacks, to drive the re-rating in valuations from still current lows. So spend what you need to do to keep production flat, get your balance sheet to where you need to get it, whether it’s half a turn debt at 45, whether it’s debt free, every board has its comfort levels depending on what form of PTSD they’re still suffering from. But when you get there, then it’s our turn to get paid and we expect in effect, that demand that seems a little strong. Do you know what I mean? 75% at a minimum of free cash flow to go back into the form of buybacks.
Jackie Forrest:
And are companies able to do that?
Eric Nuttall:
Absolutely. So I think it is a new religion in the sector where there’s an understanding that it must drive the re-rating so long as, everybody follows that philosophy. I can only think of one company that doesn’t agree. So from the smallest companies to the largest, everyone generally speaking is pledged at the lower end of 50%. But most companies, I would say it’s 75 to 100% of free cash flow.
So when we look at the large-cap Canadian names, we have most of them, and this depends on the oil price. We’re modeling about 80 bucks I think for the rest of this year. So at $80 oil, most companies in Canada will hit their final leverage metric by the end of this year and inflect to a hundred percent of free cash flow. Which to me is incredibly exciting because our thesis is the sector’s going to relate to a 10% dividend yield, which is going to be one day the same as free cash flow yield. And at $70, you’re probably looking at 13, 14% free cash yield. At $80 is close to 19 to 20% now. And so you don’t have to believe in $150 oil to see a very meaningful upside in these stocks. Just believe in $80, and I think we’re going meaningfully higher than that, but just believe in $80. If the sector’s at a 20% free cash yield and I think it’s going to relate to 10, well that’s a doubling in the average energy stock.
Peter Tertzakian:
Well, that’s a lot of the financial world’s views and so on. From a societal perspective, it’s a little bit unsettling that Western oil and gas companies in the free market are going to keep their production flat at best, which tells me that the state-owned oil companies and the Russians and others are just going to take market share in an environment where basically the Western Alliance is in a proxy war with the Russians. But that’s a whole other issue and discussion, Jackie, that we can have on energy security.
Eric Nuttall:
And Peter, on that note, I don’t want to interrupt, but a quote came to mind when you said that, and it was from a meeting with the US shale company a few months ago. And he said, “Eric, my job is not to balance the oil market. My job is to make my investors money.” And so it is such a profound change in mindset today versus four or five years ago.
Peter Tertzakian:
It’s just that there are so many things clashing right now with the geopolitics of the world. It’s something we haven’t had to deal with for arguably a dozen, some would argue 30 years, and this has potential other consequences that could lead to even more bullish markets down the road. But that’s a debate for further discussion. But on this theme of sort of foreign interests versus Western interests and specifically Canadian interests, if the stocks are as cheap as you’re saying, why are we not seeing foreign takeover bids here as we have seen in the past?
Eric Nuttall:
So, we’ll talk about foreign and then we’ll talk about domestic. So domestic typically would be PE funds. And my impression is there’s for every dollar going out at Life of Fund after seven years, there are about 10 to 15 cents coming in. And so, there’s just a lack of the deep pockets that once were are no longer as interest level remains subdued. I think Canada, we still fighting the impression of the tar sands, dirty oil, highest emissions, yada, yada. And that’s keeping if there was interest from foreign oil companies, that is keeping them at bay, especially the ESG considerations where you know, reflect on the BPs and the Shells, and I guess Shell’s pivoted, they were going to allow their production to fall by 2% per, and now it’s going to be flat. BP was going to be letting it fall 40%. Now it’s only 24%.
But I don’t think the focus is on inventory replenishment. It’s still trying to assuage people’s demands for dividend increases, debt pay down, share buybacks, freeing up free cash to invest in low to no margin renewables and alternatives, et cetera. I just don’t think we’re there because of either its policy uncertainty from windfall taxes, the drive of governments to impact oil demand through EV adoption, banning plastic straws, et cetera, and all of these different things, which erodes people’s conviction in the long-term outlook for oil where it’s just too risky.
If you’re a board today, you can’t possibly sanction a new project. There’s just way too much uncertainty, whether it’s on price, whether it’s on demand. And so just as great as the thesis is where I can get decades’ worth of free cash flow for free. I think there are too many obstacles for others to see necessarily what we see. This is why, again, it’s just so critical for companies to use their free cash flow and buy back as much stock as they possibly can.
Jackie Forrest:
Well, Eric, you mentioned that Canadian stocks have an overhang. You talked about the ESG, and the oil sands, but there are other policy overhangs here as well, such as the cap on oil and gas emissions, the Liberal government and their plans to reduce emissions generally. Does that factor in also, do you think in terms of companies not wanting to come into Canada? And does it factor into why our stocks are cheaper? The same company in the US is valued higher than in Canada.
Eric Nuttall:
Yeah, I think it does. And we have to be honest about that. Our companies trade due to a political risk discount of roughly half a turn to a full to multiple relatives to US peers. And so, I think anything the current federal government can do to assuage those concerns, whether it’s emissions cap, production cap, I think Pathways, doing anything they need to do on the federal and provincial level to make people believe the Pathways is going forward will be monumental in increasing investor interest in the Canadian oil sands. Which could lead to a meaningful rerate. To be able to buy again, I keep going back to this theme, but it still boggles my mind. To be able to buy decades worth of free cash flow for nothing. Where US shale companies have inventory problems, both in terms of depth of inventory and quality of inventory, and you contrast that to Canadian companies where we do not, and yet we’re trading cheaper than those companies. It makes absolutely no sense. So, I do think the discount being placed due to current federal government policies, I think that’s a reasonable thing to keep in mind.
Peter Tertzakian:
So just for clarification then, Eric, we’re going to have to wrap up here, the financial jargon of half turn to full turn on the multiple. So, what you’re saying is that US companies are valued at what? I’m just tossing a number, four times their annual cash flow. Is that roughly about right?
Eric Nuttall:
So, if you’re a US company with 10 years of stay flight inventory, you’re trading at five and a half to six times. If you’re a Canadian company with 30 to 40 years of stay flight inventory, you’re trading at four to five. So, there’s a huge discount, which is difficult to explain.
Peter Tertzakian:
That discount is important, and the importance of policy uncertainty being rectified cannot be understated because if companies are going to be able to achieve decarbonization goals and targets, they have to be able to access capital markets, including things like debt. And if their valuations are hampered, it’s much more difficult to do to get investor positive sentiment around such investments.
So anyway, there’s so much more we can talk about. Eric Nuttall, senior portfolio Manager, Ninepoint Partners LP. We’re going to put all the links up. But Eric, thanks so much for joining us again. It’s always a delight to have you give us behind-the-scenes views on what’s going on in the markets.
Eric Nuttall:
It’s always a lot of fun to be with you. Thank you.
Jackie Forrest:
And thank you and thanks to our listeners. If you enjoyed this podcast, please rate us on the app that you listen to and tell someone else about us.
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