Senior PM explains how supreme court rulings, international conflicts, and free cashflow are impacting prospects for Canada’s energy stocks
Rafi Tahmazian believes in Canadian oil producers. The senior portfolio manager and co-managing director of the energy team at Canoe Financial sees a confluence of global macro forces and granular corporate bookkeeping that make the sector highly attractive for investors and advisors right now. While uncertainties persist in some aspects of the global oil market, Tahmazian is clear on the advantages Canadian oil equities have right now at what feels like an economic inflection point.
Tahmazian explained some of the underlying drivers for Canadian oil in both the long and short term. He noted that domestic politics and regulatory changes could come into play shortly, but at the moment global uncertainty seems to be driving the oil market. In that context he believes the strong balance sheets and free cashflows of Canada’s large integrated oil & gas producers are a no-brainer for advisors.
“It’s the easiest trade you’ll make, probably, in your career: large liquid oil producers,” Tahmazian says when asked which oil subsector seems best set to perform in this environment. “Take the value proposition they have right now: the lack of debt, and the amount of free cash flow that these companies are generating, along with the relatively benign cost to operate their businesses…I would stick to large liquid producers and the tier one names.”
Tahmazian’s confidence in the large integrated companies over production & exploration (P&E) firms is founded, in part, on the fact that these companies tend to consolidate the industry. Right now, given attractive valuations in the space, it’s easier for large integrated companies to buy P&E firms outright, rather than incur the costs of exploring for themselves.
Where the past few decades have been defined by exploration and exploitation of new sites in oil-rich parts of Canada, Tahmazian believes the industry is shifting from an exploration focus to more of a manufacturing focus. The goal of these companies, now, is to drive down production costs and improve efficiencies. The margin those companies grow will, in turn, be used to manage debt and pay back to shareholders in the form of dividends and buybacks.
Risks in energy
There are some risks that these companies face right now, Tahmazian admits. Expansion of drilling operations could see costs begin to inflate as servicers thin out. Should that happen, margins may compress slightly. Nevertheless Tahmazian doesn’t necessarily expect a huge increase in Canadian output as much as he sees continued efficiency improvements in existing production capacity.
That view is despite the recent decision by the Supreme Court of Canada to strike down much of the Liberal government’s Impact Assessment Act. That act had held up many drilling and expansion projects in red tape and while the news is a win for the oil & gas industry, Tahmazian sees its impacts as likely longer-term. Moreover, he notes that we may very well see new regulatory efforts from this government aimed at a similar purpose.
The greatest source of uncertainty Tahmazian sees in the oil and gas space is also the greatest source of opportunity: global geopolitical risk.
What global forces mean for Canadian energy
The sudden onset of conflict in the Middle East sparked a spike in oil prices early in October. Tahmazian notes, however, that the conflict premium in energy lasted all of five days before crude dropped back to pre-war levels. Tahmazian thinks that markets haven’t adequately priced in the potential impacts this conflict might have on global oil prices.
“The global geopolitical scenario right now is so elevated, I think energy will increasingly become a topic of security,” Tahmazian says. “I think right now markets are trading on emotion and what they hope happens. I would say to investors that you should trade assuming this is going to elevate, and that’s how we’re positioned.”
On a fundamental level Tahmazian sees in these price fluctuations a misunderstanding of the developing world by the developed world. The developed world produces 30 million barrels of oil per day, and consumes 46 million. That imbalance, to Tahmazian, means global oil markets remain at the whims of governments and regions that can be gripped by conflict. His assumption, therefore, is an elevated level of volatility and a naturally higher price for oil. He believes advisors should be assuming something similar and positioning themselves in the names that can best capture value from a volatile global oil market.
“We don’t think prices are elevated,” Tahmazian says. “We think this is a natural price that the market is trading at. $60 oil is the manipulated price, because it required the US to use the Strategic Petroleum Reserve to get it down there. There will have to be some pretty significant events required to get oil back to $60.”
