Following OPEC+ meeting cuts to supply oil prices have dropped and oil equities are choppy. Senior PM explains why
The announcement of planned cuts to supply by OPEC+ last week failed to fully stop a drop in oil prices. This week, oil prices have fallen further as investors began to price in recessionary impacts on demand and started looking at the OPEC+ decision as “unconvincing.”
This shift follows a year of choppy markets for energy. Despite heady predictions about commodities going into 2023, and strong demand tailwinds throughout the year, we’ve seen pockets of supply from various geographies keep oil prices lower. Now as we shift into a deeper growth slowdown, David Szybunka, Senior Portfolio Manager & Co-Managing Director of the energy team at Canoe Financial believes the energy sector has become a stock picker’s market.
“Any way you slice and dice it, it is just a bit of a choppy oil market. And that doesn’t mean you should get totally bearish oil, but you also shouldn’t get all bullish when you have OPEC spare capacity at one of the highest levels it’s been at for years,” Szybunka says. “We’ve been seeing outflows across North American energy equities this year, and that money has been chasing other sectors of the market. When you parlay the fundamentals of choppy markets with outflows, you need to be a lot more pointed in your selection of energy stocks.
“That’s what we’ve seen on the year, certain stocks are at 52-week highs and other stocks are at 52-week lows.”
That targeting of specific names has benefitted Canoe’s fund performance over the year. He notes that success in energy investing has become truly granular. Even within subsectors there have been leaders and laggards. Much of that now has to do with the financial situation of Canadian energy companies. Szybunka highlights that in an effort to become more shareholder friendly, many Canadian names have built pristine balance sheets. Valuations on these companies were relatively similar across the sector two years ago, but investors over the past two years have favoured those more robust names and Szybunka believes we are seeing some differentiation now.
What’s happening, he says, is that the market is picking its winners. As we see their multiples expand, and other oil names contract, it can be tempting to buy the laggards. However periods like this in the commodity cycle are defined by somewhat weaker demand, and therefore those weaker names often fall off as they’ve lacked sufficient inflows to maintain their valuation. Szybunka predicts that the slight leaders now should be the significant leaders in future.
At Canoe the winners they’ve chosen tend to be long-life inventory names or companies with lots of resources and low operating costs. Those are names like MEG Energy, Ark Resources, and Secure Energy Services. Those are the names that he sees outperforming now, and that he expects will significantly outpace their peers for the foreseeable future.
Szybunka does push back slightly on the weaker demand narrative, noting that a recession doesn’t make for a washout in oil prices. A recession that creates a high unemployment spiral will wash out a significant amount of demand — as the COVID lockdowns demonstrated — but the kind of shorter recession many are predicting now is less likely to cause enough unemployment to wash out oil prices. A recession may see oil trade lower, but past examples highlight short dips rather than structural resets in price. Employment data over the next few quarters may inform the extent of any potential impact on oil prices.
Now Szybunka sees us approaching year four of a 10-15 year energy cycle that began when the market hit bottom in 2020. Commodity cycles do not go up in a straight line, they endure significant volatility through periods. Over 2021 and 2022 energy bounced off its bottom, this year it’s traded relatively flat validating Szybunka’s ‘stock picker’ thesis. The next sector-wide rally, he says, will rely on other sectors flagging and capital rotating back into energy.
“When you're in the sideways digestive periods, you need to be much more pointed in your stock selection,” Szybunka says. “You can't own everything. This is where the big divergences are happening on the year, but this is when the bigger capital does come back as we take the next leg up in the cycle, where we see the winners emerge, and other stocks don’t see their multiples expand near the extent that you think they do. They’re just cheap stocks that stay cheap.”
