Peter Linder currently works with business development and marketing relations with Matco Financial, a Calgary financial firm. He has over 40 years of experience in the oil and gas industry, and previously worked as an oil and gas analyst and fund manager. These opinions are his alone, and should not be construed as financial advice.
Peter Linder
Editor’s note: I’ve been following Calgary-based Peter Linder’s “Musings of an ex-oil and gas analyst” for some time now on LinkedIn, and have found them to be some of the most astute observations on the Canadian energy industry, anywhere. What he posted on Feb. 17, seen below, was so on the mark I had to call him up and ask if he would allow me to occasionally run some of his posts. For weeks, I’ve been trying to figure out why, during what is historically the height of the oil drilling season in this province, the two largest producers, Cenovus and Crescent Point, are running a small fraction of the drilling rigs they used to run, even during the downturn. This is one of the best explanations I’ve been able to find, yet.
With news happening so fast, especially with regards to Ukraine and Russia, I’ve provided the dates each of these posts were made, to provide context.
Without further adieu, here’s Peter Linder:
Totally Different This Time (Feb. 17)
Going back decades, whenever oil prices were strong and producers were reaping healthy cash flows, their annual capital spending plans (with the support of their shareholders) amounted to multiples of their cash flows. This was achieved via regular stock issues and very easy access to debt markets. Consequently, oil and gas production rose through the drill bit and by expensive acquisitions. And this phenomenon was certainly not limited to Canadian producers.
Then of course rapid increases in drilling activity boosted production worldwide, accompanied by much higher finding and development costs. And yet investors continued to reward these producers by pushing up their share prices, in turn reaching very high multiples to their cash flow while largely ignoring share dilution and growing debt levels.
Clearly the music had to and always did stop once oil prices started to recede.
This cycle repeated itself many times in the last 40 years.
As most of you know, times have truly changed with these stronger oil prices. For the first time ever, the industry is largely focused on generating great returns for shareholders via increasing dividends and share buybacks and is largely unconcerned about production growth. Going forward, producers’ annual capital spending will be a relatively small and in fact will steadily decline relative to their cash flow. And very importantly this trend is here to stay.
I believe this major structural change will largely eliminate the boom and bust cyclical nature of the business. Furthermore, more and more investors will realize these very positive changes and return in droves to this sector. This in return will lead to healthy multiple expansions.
For a few quality producers, their share prices will not only consistently reach 52 week-highs, but dare I say, all time highs within a couple of years!
And the only losers in this scenario (aside from those who don’t buy this story) will be investment bankers as there will likely never be another equity or debt raised by oil producers to finance growth.
Yes, it is very different this time.
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Inflation (Feb. 18)
For the next few years and almost certainly for the rest of 2022, the Canadian oil and gas sector should generate the best returns among all sectors within all stock markets, certainly far better than the Dow, S&P 500, the Nasdaq and all other stocks market indices worldwide.
The key reason: highest inflation rates in North America, Europe and other parts of the world in over 40 years will definitely result in record number of interest rate increases this year and likely continuing in 2023. This in turn will drastically limit any potential upside to these markets.
Not that the oil and gas sector will be unaffected by these high interest rates, but the outlook for this group has been and will continue to be so compelling (I may have mentioned this in the past) that investors will have no choice but to flock to oil and gas stocks for any decent returns. Ok, perhaps a few gold companies may also do well.
If I only had my energy fund today, I could be a mini (very mini) Eric Nuttall.
“If that’s all there is my friends, then let’s keep dancing” (Feb. 15)
This line is from a famous 1969 Peggy Lee song I am sure all of you remember it. Well, this verse clearly applies today to oil prices.
There are three key factors (aside from the COVID-19 virus) that could temporarily weaken oil prices: 1) no Russian invasion into Ukraine of any kind, 2) a deal with Iran regarding their nuclear program, and 3) a strong ramp up in US shale oil production.
Let’s consider all three factors. Any one of these and even all three together would only have a brief and relatively minimal impact on oil prices and then “let’s keep dancing” because thereafter there will be clear sailing for at least the next five years with oil prices well over $100 and most oil stocks up by over 200%.
Firstly, this morning (Feb. 15) we learnt that Putin was apparently pulling back some of his troops from Ukraine’s border. And after yesterday (Feb.14)’s $2.50 jump in the WTI price, it fell today (Feb. 15) by just over $3. And how did most Canadian oil stocks react today to the Putin news after a few hours of trading? They quickly recovered as the market saw huge values in oil stocks at $85-$95 oil.
Secondly, despite OPEC+ decision a while ago to increase monthly output by 400,000 bpd, the actual monthly numbers have averaged around 250,000 bpd and declining. So even if another 1 million bpd of Iranian oil comes on over the next few months it will only replace the much-needed oil that OPEC+ can’t deliver.
And thirdly, the weekly U.S. rig count is rising and likely at an increasing rate which should boost US oil production from 11.6 million bpd today to approach 13.0 million bpd in about 12-18 months. However, this production increase will come with some difficulty due to availability of drilling crews, reduced DUC’s (drilled, uncompleted wells), and capex discipline by a large number of US producers.
In the meantime, world oil demand will not only reach record highs shortly but will keep rising indefinitely, led by renewed travel demand and strong economic growth worldwide. From current levels, world oil demand should rise by another one million bpd by the end of this year and by another two million bpd by the end of 2023 to around 103 million bpd. Note that world demand was down to 85 million bpd less than two years ago.
In about a year from now, OPEC+ will be producing at capacity, oil production from the US and the rest of the world will effectively be maxed out and oil storage levels will remain at record lows. A truly happy story but there is only one way to benefit from this scenario.
I implore you to mortgage your house, if need be get a second mortgage, borrow money from your local bank, sell all your artwork, use your kids’ college education fund; take whatever means necessary and invest it all in Canadian oil producers. (This is a joke.)
And in the very unlikely event that I will be proven wrong, my wife will definitely divorce me and I will have to hide in my daughter’s house in California for the rest of my life.
Back up the truck and load up (Feb. 22)
There has been no better time than right now, possibly in the industry’s history, on a risk/reward basis, to buy quality Canadian oil producers.
About a week ago, I suggested that if I were an analyst today, I would assume US$95 WTI for 2022 in my oil producers’ models, which is at least 20 per cent higher than the street’s estimate. I may have been slightly over exuberant then, but certainly not today.
Let’s look at the facts:
- Much of the industrialized world is rapidly opening up from the COVID-19 restrictions, leading to use whatever means possible to travel as far a possible, representing a major boost to world oil demand
- Saudis announced this morning (Feb. 22) that they and the rest of OPEC will not adjust their production quotas in light on the Russia/Ukraine situation
- The Iran nuclear negotiations are still ongoing and although they are proceeding well, there is still no settlement
- World oil storage reserves are near record lows
- Russia, the world’s second largest oil producer may shortly have some of their oil exports curtailed and Nord Stream 1 gas pipeline to Western Europe May be shut down, providing additional boost to oil demand
- We are entering the Q4/21 reporting season for the Canadian midcap and small producers which should be “Marvelous!”
- Assuming US$90 WTI for Q1/22 and US$95 for Q2/21; the announcements would most of these oil producers make regarding free cash flow, dividend increases, share buybacks, debt reductions, and future production growth would be unprecedented, and
- Last but certainly not least, the aggressive moves by Putin yesterday (Feb. 21) towards Ukraine is not only very serious and will likely escalate but also, it will unlikely have a peaceful resolution anytime soon.
If I were putting together a list of the most positive factors for sustainable high oil prices, all the above would be on the list. Today and for the foreseeable future, I truly don’t see any other place within the TSX to park one’s money but with Canadian oil producers.
Peter Linder currently works with business development and marketing relations with Matco Financial, a Calgary financial firm. He has over 40 years of experience in the oil and gas industry, and previously worked as an oil and gas analyst and fund manager. These opinions are his alone, and should not be construed as financial advice. You can follow him on LinkedIn here. He can be reached at ptlinder@yahoo.ca.
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