Energy sector shows signs of life, needs long-term investors
Meaningful pick-up in consolidation, oil price stability
Despite the ongoing rally in energy markets fuelling a good start to the year on the S&P/TSX composite index, the underperformance gap with other major indexes continues to widen, as it has for the past five years.
The S&P/TSX composite index is up nearly five per cent this year, but that lags the S&P 500’s 5.75-per-cent gain, and the 10.5-per-cent increase posted by the MSCI emerging Market index.
Looking ahead, our country’s exposure to inflationary components such as energy, utilities and materials should help narrow this gap in a post-covid-19 world, but we must get there first. There continue to be worries about the federal government’s extremely slow vaccine rollout, which has a domestic economic cost as well as a global one, since Canada risks losing market share as other economies reopen faster.
The united States, for example, is vaccinating 1.7 million people per day, which is more than the 1.3 million Canada has done in total. On a per-person basis, the u.s. is vaccinating people at nearly 4.5 times the pace we currently do.
Pair this with a record-setting fiscal deficit and a lack of transparency about how the government’s spending programs are being deployed, and it certainly doesn’t provide much comfort in the underlying fundamentals backstopping our economic recovery.
That said, it would be ironic if our energy sector once again comes to the rescue, especially considering Justin Trudeau’s comments a few years ago that it should be phased out.
This rebound scenario could well play out, given that a lot of good things are happening in the energy sector that could end up having a meaningful near-term economic contribution. Oil prices are showing signs of stability, with recovering global demand resulting in large inventory draws thanks to compliance within the Organization of the Petroleum exporting Countries to keep prices at or above current levels.
besides being temporarily impacted by record-setting cold temperatures, u.s. shale production is potentially facing longer-term punitive policy action under Joe biden’s administration, such as pipeline constraints, further restrictions on where it can drill and even fracking limitations.
Meanwhile, Canada’s industry is experiencing a meaningful pick-up in consolidation that will result in it being dominated by a few players, not unlike our banking and telecommunications sectors. The positive is that there will be continued improvements in operating efficiencies and an ability to prevent costs from inflating as much as in previous booms.
Among the large caps, most of the foreign companies have exited the country, leaving Suncor energy Inc., Canadian Natural resources Ltd. and even Cenovus energy Inc. as the go-to names in the space, and yet all three are still trading at a sizable discount to the current oil price.
We’re also seeing consolidation in the intermediate sector, including the recent $8.1-billion merger between Arc resources Ltd. and Seven Generations energy Ltd., and Crescent Point energy Corp.’s $900-million purchase of royal dutch Shell’s duvernay assets.
even the infrastructure sector is experiencing interesting activity, as is evident by brookfield Infrastructure Partners LP’S takeover bid for Inter Pipeline Ltd.
All this activity should result in significant improved cash flows and the associated economic benefits, but don’t expect material organic growth in the sector, because there is a lack of interest from institutional investors to provide the capital required to fund large project expansions.
This means that there are currently much better incentives to distribute excess cash flow in the form of dividends, share buybacks and debt reduction rather than putting it back in the ground.
While this will have a near-term economic benefit, over the longer term, one has to wonder where our country’s growth is going to come from?
Not surprisingly, Canadian investors, especially those looking for growth, have decided to leverage up and speculate on real estate instead, while many others appear content as long as those dividends keep arriving. This is not a good path we’re on: real estate is a non-producing asset and dividends siphon capital out of innovation and growth.
If there was ever a time to build back better, now is it. Sticking with the status quo means Canada risks being permanently left behind as the gap with other markets simply becomes too wide to catch up.
Martin Pelletier, CFA, is a portfolio manager at Wellington-altus Private Counsel Inc. (formerly Trivest Wealth Counsel Ltd.), a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax and estate planning.