Investor attitudes toward the oil patch are shifting practically by the day – a product of the sector’s soaring profitability, combined with renewed urgency around global energy security as a component of ESG investing.
The world’s dependence on energy products from autocratic regimes is being frantically reappraised, including by investors focused on environmental, social and governance issues, as Russia’s war in Ukraine has threatened fuel supplies and pushed crude oil prices in excess of US$100 a barrel.
This week, a Bank of America report predicted the emergence of a “new energy world order” with Canada named a key beneficiary, as a major oil producer that offers investors political stability on top of commodity exposure.
“Buy Canada,” the analysts suggested, pointing to superior earnings growth, low valuations and generous dividends – a remarkable reversal of fortune for a sector that spent the previous decade in decline.
“They were all pretty much bankrupt two years ago, and now they’re virtually debt free,” said Rafi Tahmazian, senior portfolio manager at Canoe Financial. “In my career, I’ve never seen a more lucrative environment to put capital to work in this sector.”
Current energy prices translate into incredible cash flow for an industry that has adapted to survive on far less. Cenovus Energy Inc., the country’s second-largest oil and gas producer, reinforced this fact with first-quarter profits that were up by more than 600 per cent from the same quarter last year, according to results released on Wednesday.
The company nearly tripled its dividend and committed to returning at least half of its excess free cash flow to shareholders. Such is the new mantra in the oil patch: Massive capital investment and rampant drilling is out, debt reduction and dividends are in.
The numbers have become impossible for investors to ignore. Energy is by far the best performing sector of the past year, with the S&P/TSX Capped Energy Index having more than doubled over that time.
“Sophisticated investors let a few quarters go by before they started believing in it. But you’re starting to see the believers show up, especially as the tech market deflates,” said long-time Calgary energy economist Peter Tertzakian.
“Whether ESG-conscious investors are buying it yet, I think they’re at least curious.”
The divestment movement, which targeted the oil sands as a dirty, emissions-intensive industry, saw waves of large investors like pension funds unload Canadian energy holdings as a matter of principle.
By that point, the oil patch was already on the wrong side of the energy market cycle. A global oversupply generated in large part by the U.S. shale boom crushed sector profits.
It got worse from there. The debate over pipeline projects became bitterly divisive as the industry struggled to get its product to market. Then the pandemic hit, and demand for oil collapsed as much of the world went into lockdown.
Investors here and abroad, burned too many times by Canadian oil and gas stocks, increasingly saw the sector as uninvestable.
Sentiment toward oil and gas has been slow to adjust ever since. ESG investors certainly didn’t miss the sector, as the dominance of tech stocks propped up returns for many investors who shunned fossil fuels.
But then Big Tech and Big Oil effectively traded places on the leaderboard. Now, many professional investors with little or no energy exposure will struggle just to keep up with market returns.
The same goes for fund managers constrained by sustainable investing mandates, which are facing scrutiny in light of Russia becoming a pariah state. A recent report by CIBC World Markets pointed out that the global ESG fund space owned twice as much Russian energy stocks as Canadian oil and gas as of the end of last year.
ESG scores have been overly influenced by simple carbon metrics, the report said. “The notion of political risk is assuredly one that was under-represented by ESG data providers.”
Meanwhile, Canada’s oil and gas industry is attempting to align itself more closely with the global effort to fight climate change. The Oil Sands Pathway to Net Zero initiative is an alliance of companies representing nearly all of oil sands crude production dedicated to cutting net emissions to zero by 2050.
It’s unclear if a rebranding of Canadian oil will gain traction in green investing circles.
“We’ll see if the market is willing to buy into that narrative,” said Robert Fitzmartyn, head of energy institutional research at Stifel FirstEnergy. “It could be a tough sell.”
But profits have a way of weakening principles.
The industry is expected to pay a total of more than $7-billion in dividends this year, which has grown from less than $3-billion in 2009.
There is no sign of any major change coming soon to the supply-demand imbalance in the global oil market. On Tuesday, the World Bank said it expects resource prices to remain “historically high” through the end of 2024, in light of “the largest commodity shock we’ve experienced since the 1970s.”
“As an investor, you could not possibly ask for a better situation,” Canoe’s Mr. Tahmazian said. “These businesses are already cash machines. Anybody that’s not part of the party right now, get on the wagon, because there is lots more to come.”
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