Some weekend oil market thoughts
Hi everybody,
It’s been quite an eventful weekend in the world of geopolitics. Surprisingly things that would have previously excited the oil bulls from a market perspective have them sitting in the corner acting timid. From what I have seen, most bulls and bears alike remain highly skeptical of the crude oil move as a significant conflict between Iran and Israel has fully broken out. Even NCP, who was a skeptic that actual warfare would occur at this scale has been taken by surprise. Nonetheless, for the past couple months we have been in the bullish oil camp - and didn’t expect further downside as notable oil bulls capitulated and had been calling for a $5 or $4-handle crude price.
It feels important to note that a significant portion of the recent crude move into the $70s was completed before the Iranian-Israeli conflict broke out. Oil bears had been expecting further price breakdown on the resolve of the OPEC meeting, in which the cartel had announced they were adding supply to the market. It was the status quo decision, as some fake news outlets had been suggesting an even larger hike or marketshare wars. So far, incremental OPEC barrels have not been seen. Hence, the crude move has been sharply upward since the announcement. Other small things may have played a modest role, such as the Canadian forest fires which shutdown a significant portion of production. However, much of that production has resumed.
THE WAR BETWEEN IRAN-ISRAEL IS REAL & SHOULD NOT BE DISMISSED
As stated, I am surprised by the extent of the war. As I noted numerous times on X over the years, I always believed Israel would simply continue their killing spree of Iranian scientists and military officials as they saw fit with the occasional bombing of their nuclear facilities as they have done numerous times in the past. This time the conflict has become severe. While I expect that Israel has the ability to overwhelm Iran with more destructive methods should the conflict intensify, so far, it is a tit-for-tat battle with attacks on each others cities. The attacks tonight showed Iran hitting residential apartment towers in Tel Aviv which is significant. Israel has always placed a high emphasis on their citizens lives so NCP would expect a very harsh response from Israel that may bring substantial collateral in Iran. That’s just the way Israel does business. You can see their tactics in both the Palestinian territories and southern Lebanon with respective militant groups. Iran’s Revolutionary Guards are the custodian of the country’s oilfields and revenue. With most of Iran’s revenue coming from petroleum, an attack on their prime oil export facilities no longer sounds far-fetched, especially after the residential apartments in Tel Aviv were hit tonight. Israel could choke off the regime’s revenue by totally cutting off their oil exports, which mainly go to China. This would be a significant loss for the IRGs.
TIME TO BUY OR SELL OIL STOCKS?
In my view, the time to buy oil stocks was over the past couple months when all the bulls capitulated and 52-week lows were being set. NCP went pretty heavy into oilfield services (ACDC, PDS, PTEN) were a few we added. I am still long PDS and have some PTEN shares and expect both to do well. In the past week I added a small cap Canadian oilfield service company called STEP Energy (TSX: STEP) as it is trading at an extreme discount relative to peers with potential stock-specific catalysts and a new technology coming online which may result in EBITDA growth. I plan to write more about STEP in the coming week or so to outline my thesis. As NCP believes the move towards $70 was fundamentally justified, whether you buy or sell should base your perspective on that. My thesis on oilfield services was the sector was oversold and that the United States shale patch will have to improve activity levels for LNG and that the shareprice declines were in excess to potential EBITDA loss for the oilfield service companies, a fact that is only more convincing today as both natural gas and oil prices have improved and may continue to do so. A loss of Iranian barrels would further stimulate domestic drilling and completion activity. I believe a number of names in the oilfield service sector continue to offer considerable upside for those who can stomach the volatility at times. NCP is still long Strathcona Resources (TSX: SCR) a name that has been in the news more then usual of late as they made a back-door takeover bid on MEG (TSX: MEG) with market purchases of shares near 52-week lows while they spun off their Montney natural gas assets to Tourmaline, CNRL and Arc for a considerable sum that would allow the company be potentially debt free. I continue to believe Strathcona Resources offers investors substantial upside as the company is likely to get a multiple re-rate and still trades at a meaningful multiple gap to peers due to extreme low liquidity and lack of indexation. Aside from the names NCP is already long, we would prefer to wait for a pullback in the space before accumulating further or starting new positions. But it is important to note, current valuations are not ‘crazy’ and the sector doesn’t strike me as frothy nor does the commodity, especially given the real prospect of Iran losing barrels here.
IRAN IMPLICATIONS FOR THE OIL MARKET
In my view, Iran is weaker then they have been in many years and I believe the Ayatollah regime is at risk. Khamenei, the successor of the 1979 revolutionary from exile Khomeini, acts as the grand ruler overseeing the democratically elected members if the government. It’s a theocracy run by Ayatollah’s which not all Iranian are in cahoots with. Some may know that prior to the Ayatollah regime, the country was run by a Shah which was largely secular. It is possible that the Ayatollah regime is toppled, either externally or internally - or a little bit of both. That is the way NCP is leaning although this outcome seems like a medium or longer-term event as it is unlikely to go from A to Z without conflict in between. I believe that a new Iranian regime could be “pro-western” or it possible they allow the Ayatollah regime to cling to power as they take out their oil and force them to surrender on nuclear. In this case, it is difficult to see the ‘hardliners’ approve of this which may lead to Iranian conflict. NCP has been really skeptical that Iran would lose barrels but after the attacks on Israel’s residential apartment blocs tonight, I am now leaning towards an Iranian oil TKO as it is the going to cut the IRG’s off their income stream which would make it much more difficult to fund the costly attacks against the Hebrew State. According to the latest data, Iran exports around 2 million barrels per day of oil and products (Source: Reuters). Such a loss would have meaningful implications for oil prices.
OTHER MARKET IMPLICATIONS FROM THE ISRAEL-IRAN WAR
The conflict with Iran-Israel seems likely to draw in the United States even if Trump says that the US will not be getting involved. The attacks tonight in Tel Aviv appear to be significant and it seems unlikely that the US will stand idly. Historically UST bonds would catch a bid during periods of uncertainty but so far that trade has not been a good one as long-term bonds have gone back towards their 52-week lows despite very deflationary macro prints of late. It is possible that higher energy prices pushes up inflation which may further weigh on US growth prospects, which may in turn end up as a ‘bond bullish’ event as the US economy slows down. Most macro thinkers seem to be leaning towards rising inflation because of Trump’s tariffs, although the impact has yet to be felt. A further major conflict in the Mideast may have market implications for the United States and raise uncertainty. Another significant conflict could potentially influence other conflicts whether it involves Russia-Ukraine or perhaps China, the major source of Iran’s revenue stream. It is too early to make conclusions but in my view it is worthwhile to consider and watch. With Syria’s Assad regime gone, Lebanese Hezbollah largely decimated and Sunni-Jihadist Hamas also licking their chops from a pile of rubble, it is hard to be bullish Iran in any sort from a military conflict as they have been badly wounded. Iran mostly stands alone with limited allies in the region and world. Perhaps their biggest friend is China, who is there by virtue of economic interests only. Iran’s fringe ideology with Shia Khomeinism puts them into the rabbit hole with limited friends.
OTHER PORTFOLIO MOVES IN THE PAST WEEK
As I wrote in the past week or so, NCP initiated a position in Rogers Communication (TSX: RCI.B) a name which we consider super defensive. It has traded well in market routs as the selling exhaustion in the telecom space appears largely done. On Friday, NCP was able to add a few thousand Dream Residential units and this company remains my highest conviction pick of any name. On Friday I was also able to add some more units to Riocan REIT. I am largely sticking with ‘defensive’ names with perceived catalysts to unlock unit price appreciation. In recent times, this mainly has to do with asset sales from public to private market hands as the arbitrage in the space between private-public is extreme. In energy, as noted in the aforementioned, I initiated a position in Canadian oilfield service company STEP (TSX: STEP). It’s down about 28% from the take private attempt only months ago, as an opportunistic hedge fund blocked the deal in aspiration to get a better price from Arc Financial. I believe this is one of the best risk-reward names in the space for those with at least a medium term vision. I plan to write further about STEP and OFS in the coming weeks.
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
I like your thinking with this. STEP definitely has some leverage to increasing activity. Something like CFW even more so if they can get activity to cover their subscale US exposure.
Thanks for the update / write up, appreciated. I would like to add that i believe Iran isnt as toothless as most people seem to believe. They have significant stockpiles of somewhat advances missiles and its obvious by now that its practically its impossible to defend against missiles and drones (see Ukraine, now Tel Aviv).
Also consider population and landmass (10 million vs 100 million, landmass 1:75) and its clear (to me at least) Israel cant win a fight vs Iran on its own.
Im terms of how this impacts oil, i guess Trump told Israel not to attack oil production and so far they do abide.