Fund manager optimistic on energy
Investors have a tendency to overshoot on both the upside and downside. For example, Goldman Sachs in 2008 called for oil to hit US$200 per barrel in the not-too-distant future. Prices, of course, have collapsed, as the U.S. shale revolution unlocked an unprecedented amount of reserves, causing supplies to dramatically rise as demand tailed off because of weakness in China and some emerging markets.
But Jason Whiting of Trimark Investments is confident that a supply-led recovery will boost the price of oil, just as supply caused prices to fall.
He noted that the number of rigs drilling for oil in the U.S. has dipped about 56 per cent from the peak in October 2014, and existing wells have a natural production decline rate of about 30 to 40 per cent each year.
“Just as the law of supply and demand worked to push down the price, I think it will also work to push up the price,” Whiting said.
That’s a big reason why the portfolio manager of the $600-million Trimark Canadian Small Companies Fund has a weighting of roughly 25 per cent in energy and related industries.
“You have to keep drilling to replace the barrels that an oil well loses,” Whiting said. “But because drilling is down so much, that won’t happen.”
Supply has already fallen about five per cent from its peak earlier this year, but since few, if any, companies can afford to drill at current prices, banks aren’t issuing energy companies more debt, and shareholders don’t want to pony up for more stock.
“The capital markets have shut off their ability to drill, and companies can’t get good returns at US$45 oil, therefore supply will be reduced,” Whiting said.
He thinks oil will be back in the US$70-to-$75 range in the next three to five years — a level that encourages a more appropriate amount of supply to replace what’s lost from declining well rates and increased demand.
As a result, Whiting thinks there is enough upside in oil stocks for patient investors to be well-rewarded, which is why he is targeting names based on valuation, not potential catalysts in the energy market.
The portfolio manager is even more optimistic about natural gas.
Producers are three or four years ahead of their peers in the oil space when it comes to reducing costs and managing a weak commodity price environment, and they also have a powerful secular driver as a tailwind, namely declining oil supplies.
Whiting explains few companies are drilling for natural gas, but supply has remained elevated since many oil plays also produce associated gas. If oil supplies go down because of less drilling, gas supplies will drop accordingly.
In the longer term, he also thinks the demand picture for natural gas is better than oil.
“Oil demand should grow, but it faces pressure from things like more efficient cars that reduce the amount used,” Whiting said.
Natural gas, meanwhile, will benefit from the ongoing push toward clean energy as more people switch away from coal.
There is also the impending arrival of liquefied-natural-gas facilities in North America — likely one or two on Canada’s West Coast and probably three or four in the U.S. — in the next five to seven years.
“That means a big boost in incremental demand for these facilities to ship gas globally, where prices are much higher,” Whiting said. “So gas has a good demand story going for it.”
One of his top holdings is Advantage Oil & Gas Ltd. (AAV/TSX), which is 100-percent weighted toward gas and has one of the lowest-cost natural gas assets in North America.
“In a commodity business, if you are the low-cost producer, that is a sustainable competitive advantage,” Whiting said. “Lots of companies will be forced to cut production if prices weaken; Advantage will still be able to produce.”
He also pointed to its credible growth platform and internally-generated cash flow.
“If you’re not sure about timing, the key is surviving the downturn,” Whiting added. “Yes, these types of stocks can always go lower, but I don’t have to worry about the business being impaired.”
Another fund holding he highlighted was Painted Pony Petroleum Ltd. (PPY/ TSX), which is also 100 per cent natural gas with a focus on the Montney region, but is at an earlier stage in terms of growth.
If you’re not sure about timing, the key is surviving the downturn