Is it time to buy Canadian oil stocks?
Hi everybody,
I wanted to write a note tonight about some thoughts on whether there is an opportunity in oil stocks as early as today as it is now past midnight. As I wrote on my Twitter, I managed to liquidate about 10% of my portfolio into cash two days ago near the end of the day when I saw US Commerce Secretary Howard Ludnick’s comments about making a potential trade deal with Canada at the last minute. In reality after tabulating the total raised by closer to 8%, but I was excited that I was able to prep up some cash quickly. As noted on Twitter late yesterday, I indicated that I deployed that cash. The stock I added was Cenovus and I purchased it after it fell another ~3%, only for it to fall a further percent into close! Ironically, the likes of Baytex and Veren were both in the green while Cenovus and Suncor were thrown around like rag dollars - talk about an insult to injury. No wonder retail investors are fed up.
Now normally NCP does not focus on day trading nor is it a mainstream strategy but these tariff talks has created significant volatility which a savvy trader may capture some alpha out of. On the other hand, in energy specifically, the recent annulment of OPEC cuts has led to energy stocks facing a merciless pulverization not really seen since the 2020 virus era. What we saw this week was the worst we have seen in ages and it has led to numerous energy investors capitulating in the sector which had already seen significant struggles to retain investors due to poor sentiment and a prolonged period of depressed pricing. To see big companies like CNRL thrown around like rag dolls was quite a sight. Ultimately I did not think the OPEC decision was much of a surprise as many of us were skeptical that cuts would continue.
OPEC CUTS WERE BEARISH, THE BANDAID HAS BEEN RIPPED OFF
In NCP’s last article, it is noted that we find the OPEC cuts as bearish (see link). Historically OPEC cuts are put it in place because supply has overtaken demand and of course the same can be said when OPEC reals in the cuts. In this case we are not sure, because there is an element of political pressure, particularly with Russia which has indirectly joined OPEC hence it is now OPEC+. Russia is in the process of making a critical deal on the Ukraine with Trump who is a vocal proponent of lower oil prices. It seems like a hypothetical trade off between USA-Russia under Trump-Putin would be to allow for Russian barrels to stay on the market in return for a favourable outcome on a ceasefire in the Ukraine. OPEC always has a more bullish outlook for oil demand then alternate sources, some of which are politically tainted such as the IEA and can no longer be relied upon. If you believe that OPEC ended the cuts because they foresee strong demand, this outcome is bullish.
TARIFFS HAVE IMPACTED CANADIAN OIL, WATCH FOR NEWS IN THE MORNING
Late last night, US Commerce Secretary Howard Ludnick had an interview with CBC in Washington after the Trump speech in which he reiterated that he anticipates some type of a deal or reduction in tariffs as early as tomorrow. It seems that many Canadian stocks, including energy, have seen weakness due to these tariffs. NCP is of the view that any positive breakthrough on the tariffs tomorrow could result in a potential powerful rally in certain names. It seems many names sensitive to tariffs bottomed today as some of the most impacted names were barely down on the news. Energy stocks have suffered disproportionately to other components on the TSX. It is very clear to NCP that the Trump government sees Alberta’s oil favorably and overtime I believe that relationship will become a positive for the sector.
OPEC WAS ALREADY CHEATING, THE SELL-OFF SEEMS DISPORTIONATE
Most of the outcome from the OPEC meeting was already known but only not officially stated by the cartel. For instance, it was widely known that Kazakhstan was ramping up production and that United Arab Emirates had the prerogative to grow due to a prior deal. There were plenty of reports suggesting that Kurdistan oil would re-start on the Ceyhan pipeline to Turkey due to US pressure which could add incremental supply to the market. The production adds are relatively modest if you believe the numbers and unlikely to make a huge difference. The key to watch here is demand. Lower oil prices is stimulative to demand. With this band-aid off, the bear case for the oil industry is lessened. It is much better to buy into oil after the end of the OPEC cuts then with that overhang over us as investors. Almost every single forecaster is predicting an uptick in global oil demand, so a slow pace of OPEC cuts coming back onto the market may not have much impact if any at all, especially if lower commodity prices helps stimulate an uptick in demand. NCP firmly believes the market’s reaction was excessive and there wasn’t much ‘new’ news announced.
LOW OIL PRICES ARE EXTREMELY BEARISH FOR US SHALE
While NCP are on record plenty of times suggesting that US shale oil is not the main bear case for oil this time around, one cannot ignore the adverse impacts that low oil prices and further political uncertainty may have on the mighty US shale sector. NCP is of the view that the current commodity price is significantly below where it would have to be to stimulate production growth on the oil side in the space. It seems likely that we will get modest offshore growth in the US this year but it will be interesting to see whether US shale oil can even hold the status quo. US D&C activity is low by numbers so this is an important factor to watch. Any production falling would be a clear signal on the price front that oil is far too low for American shale. NCP is of the view that we need $80 or higher to wake up the US shale oil drilling appetite. Trump administration’s plan to increase US drilling are simply not going to happen anywhere in the current price band. It is likely we see an increase in production on the natural gas side if we have $4+ NYMEX strip but it is not likely on the oil side at all.
CANADIAN OILSANDS ARE A DEFENSIVE SOURCE OF SUPPLY
As noted in the aforementioned, Canadian oil has not only been under pressure due to lower oil prices but also because of the 10% tariff overhang imposed by Donald Trump. Investors are very scared, which has created a very strong buying opportunity when you add being scared with tariffs, OPEC cuts coming to an end and low commodity prices. If there is anywhere NCP is comfortable to hang out in the $60s for oil, it would be Canadian oilsands. Yesterday NCP took a fairly significant personal position in Cenovus, one of the most out of favor names in the sector. They have amongst the best upstream assets in the industry including the best asset in the oilsands business at Christina Lake. The weakness from Cenovus was from downstream as Chicago crack spreads have been near Covid levels in recent times. Low oil prices can benefit downstream as it can help crack spreads due to lower feedstock costs. Much of Cenovus’ refining exposure is located in the United States so hypothetically shouldn’t be exposed much to tariffs regardless should they end up sticking. In the case of Cenovus, only $7-$9 sustaining capex is quite stunning. Should downstream improve, Cenovus will be poised to outperform the peer group.
Other preferred ideas in the space: Strathcona Resources, MEG Energy
IN A NUTSHELL
Like many other investors, I am watching to see what happens between now and tomorrow morning and will try to stay a bit more glued to the various media sources throughout the day as big news could lead to a favorable trading opportunity on the Canadian market and not just in energy. I know that sounds amateur but the wild swings have been extreme and there is a lot of money on the sidelines. I can’t recall how many posts and comments I have read and heard from individual investors in the past month stating they will redeploy capital when certainty appears. After all, it was Warren Buffet who famously said that investors pay for certainty.
In regards to oil specifically, I believe that if you want exposure it is much better to add exposure now then last year. Most of the bad news is priced in and the only remaining ‘bad’ news I can think of could be Iranian barrels staying on the market or some type of deal in Venezuela. It seems unlikely that either news would carry enough clout for a significant drop down. Therefore, NCP is rather comfortable to assume that for the coming months, the trajectory of crude is more likely to be higher then lower, and if it falls further we would be inclined to make it a buying opportunity. While it is possible oil stocks do not move for months, the opportunity to add “and wait” until conditions in the space strikes me as favorable.
In short order, NCP prefers to stick with high quality low decline sources such as Canadian oilsands names. Heavily indebted short-cycle names like Baytex or Veren may bounce in the immediate term but are most at risk if low oil prices persist. Even the largest US shale names will see significant cash flow erosion at the current strip. Low decline oilsands names have gone down with the lower quality names in recent weeks and offer a more protective stance on the downside and still have torque to the upside from the current valuations due to an excessive beatdown. NCP strongly prefers oilsands names over short-cycle shale or Montney names at this time.
At the end of the day, NCP’s approach to the sector has been more of an active trader then a passive investor. For those with a committed passive approach to the sector, you may see this as a time to simply add incremental positions. This time will not be different for NCP. While we are happy to remain long investors in the space, should business conditions in the energy sector decline, NCP tends to plot an exit rather then stick around for the ride. Contrarily, if NCP detects an improving opportunity in the energy space, we will not shy away from increasing our positioning to the sector. NCP believes the recent sell-off has given investors the potential to participate in meaningful upside in numerous names with a modest recovery in oil prices.
NCP will write more detailed thoughts as clarity on the situation emerges.
Thank you for reading and as always, if you have any questions or comments please leave them in the comment section.
Yours truly,
Roger Lafontaine
Partner, Head Trader & Research Analyst, Nugget Capital Partners
you called the bottom so far!
Thanks a lot for the timely update / thoughts.