Eric Nuttall says his energy fund has the right stocks. It's just a matter of the market realizing how cheap they've become.
Mr. Nuttall, manager of the Sprott Energy Fund and an oil bull in a field of bears, has gone all-in on U.S. shale – production, oil-field services and providers of the sand used in hydraulic fracturing. Only one of the fund's large holdings is based in Canada.
U.S. shale-oil plays such as the Permian and Eagle Ford in Texas have been magnets for busy drilling, largely because of quick payouts for wells in the sweet spots of the formations. That's key as crude oil has languished below $50 (U.S.) a barrel.
Still, the fund has suffered in a market that's turned its back on all things oil and gas after three years of downturn. As of the end of July, it was off nearly 45 per cent from the start of the year, on the heels of a hefty gain in 2016. That's despite largely positive recent quarterly results among the companies in the portfolio. By comparison, the S&P/TSX capped energy index is down 23 per cent this year.
"I think they're suffering from two things – one is a complete buyers' strike. There have been too many false starts this year where oil and, by extension, energy stocks have rallied only to correct. People have been hit over the head one too many times," Mr. Nuttall said in an interview.
"At the same time, I get reports of generalist funds decreasing their energy allocation and energy funds shutting down … so forced sellers. Weakness has been begetting weakness."
Recent fundamentals in the crude market have been positive, he said. That includes data showing that the glut of supplies that has weighed on prices is shrinking while demand remains on track.
Last Wednesday, the U.S. Energy Information Administration reported that stockpiles fell for the seventh consecutive week to their lowest since the start of 2016. Oil prices rose only slightly, however, as traders took notice of U.S. output rising and chalked it up to the continuing rebound in U.S. light, tight oil production.
The increase, to 9.5 million barrels a day from 9.4 million the month before, was more the result of Alaskan output returning following maintenance than big gains in shale production, Mr. Nuttal said.
U.S. inventories have fallen by 110 million barrels from their February highs, but the market is largely shrugging it off, he said.
"The ingredients for a bull run in oil are there. We just need people to recognize and appreciate them," he said.
Among the funds largest holdings are such U.S. companies as WPX Energy Inc., Parsley Energy Inc., U.S. Silica Holdings Inc., Propetro Holding Corp. and Continental Resources Inc. Its sole large Canadian holding is Trican Well Service Ltd., the Calgary-based fracking company.
"Multiples of the names that I own have fallen by half. Names are trading below where they were when oil was at $26, so clearly sentiment has swung extremely bearishly," Mr. Nuttall said. "The data would suggest there's not a lot of support for the level of bearishness."
Mr. Nuttall, who in 2015 had as much as a 70-per-cent cash weighting in his fund, isn't holding back when it comes to betting on a rebound: "I'm fully invested in the upside of the sector," he said. Of course, the main risk is the downside.
The past three years of oil-market downturn have been rough on energy funds, with some closing and others cutting portfolio managers amid poor returns and outflows of capital.
Indeed, last week British-based energy and commodity firm OAK Capital LLP ceased trading after four years in existence. That followed a decision by Astenbeck Capital Management founder and oil-market guru Andy Hall to shut the firm's main hedge fund following steep losses.
Mr. Nuttall said his fund has had net capital inflows this year despite negative returns, and energy remains a key part of Canada's economy even as bearishness persists. Globally, the clawback in corporate investment into oil production will start to hit output levels as early as 2019, he said.
"We remain in a bull market for oil, but you certainly would not know that if you look at the oil prices today. So my hope is with the continuation of drawdowns in U.S. and OECD inventories, you'll see an inflection in sentiment and an oil price that better reflects reality."