Oil & Gas sector

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Equity analyst Jeremy McCrea joins the podcast to discuss the oil and gas sector, including:

  • Overview of the sector
  • What Jeremy is looking at when he’s reviewing a company/the sector
  • Outlook for the rest of the year

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Chris Cooksey: Hello and welcome to the Advantaged Investor, a Raymond James Limited podcast. A podcast that provides perspective for Canadian investors who want to remain knowledgeable, informed, and focused on long-term success. We are recording this on September 7th, 2023. I'm Chris Cooksey from the Corporate Communications and Marketing Department here at Raymond James, and today I'm speaking with equity analyst Jeremy McCrea.

Jeremy will be sharing his insights on the important oil and gas sector with us today, and he has been on the podcast before, so check him out in the archives. Obviously it's a sector that's very important to the Canadian economy, so I'm looking forward to hearing Jeremy's thoughts. Jeremy, welcome back to the podcast, I hope you're doing well.

Jeremy McCrea: Yeah, that's great. Thank you.

Chris Cooksey: Excellent. Always lots to talk to, talk about here. So we'll jump right in and maybe we'll start with a 10,000 foot view. What's been going on in the sector? Maybe, mostly in the second half here and as we go towards 2024.

Jeremy McCrea: Yeah, since July 1st, we've seen oil prices jump 25, 26, 27% here, and every day they keep going higher and higher, and I think it's catching a lot of guys flatfooted, just in terms of how quick this oil rally has become. I think one of the big things that you're seeing here is Saudi Arabia is taking an offensive position saying if we are heading into a recession, we don't want to be reactive. We want to push inventories and cut back on our production first and be pre-emptive to this recession as opposed to historically always being reactive. And as a result, you're seeing oil prices continue to move up, especially with the recent cut here this week extending their million-barrel per day cut all the way to December. Now that I think was a lot longer than I think anyone was anticipating.

Chris Cooksey: Now I imagine the war Russia, Ukraine is still affecting things, or, or has that been pretty much priced in and people are moving on as if, and I mean obviously they exist and obviously Russia's still selling oil to some people, but how is that still affecting the market?

Jeremy McCrea: Yeah, it's still affecting the market just in terms of not knowing what they're going to do, almost, in a way, and just the unknown is a huge factor in oil and gas. We can all kind of see, you know, here's how much every country is supposed to be producing. We can kind of get an idea of where inventory levels are going to be. But it's these black swan events that suddenly push prices up or push prices lower. And we get them all the time it seems like now. And so I think the unknown with Russia is, how much are they going to produce? Are they going to go in line with what Saudi is pushing for? Are they going to overcome these restrictions that the OECD countries are putting on them? And I think that's just still the unknown and how their ability to sell oil and, and even natural gas for that matter too. So, but it's just another global factor that is putting, you know, and putting a bit of a premium in the oil market here still today. Okay. Not as much, but it's still, it is right now.

Chris Cooksey: You were recently quoted an article on Yahoo Finance. They were talking about the banks and their results and sort of the provisions they're making around loans and that sort of thing. And you have noted that the loans to the industry you cover, or the sector you cover have changed dramatically over the last few years. So maybe just touch on that.

Jeremy McCrea: Yeah. One of the interesting things that's always come out with banks and oil and gas is we don't want to lend to energy companies anymore here. They're bad risk. And as a result, you know, bank lending has always dictated a large part of how much spending oil and gas companies could really do here. But I think one of the more interesting things that if you look at where oil and gas loan impairment is now 94% from just a few years ago here, like a pretty astonishing rate. And when you actually look at oil and gas loans, there's less impairment on oil and gas loans than all the other loans that the banks lend out to here. So, it's a complete reversal of what we've historically seen, to the point where you almost want banks to own oil and gas because it reduces their overall concern here, that’s we're seeing. So, it's just a kind of a change of pace that, that we're seeing since I've been doing this for 20 years. Like, I can't remember any time that this has ever been the case.

Chris Cooksey: Okay. And what are you really concentrating on right now in the sector? Is there elements of it that are doing okay or anything like that? Or where are you really concentrating your efforts right now?

Jeremy McCrea: So one of the biggest things I always look for in oil and gas is rate of change. And so as much as we look at the commodity and talk about the commodity, the commodity's going to go up and down with these black swan events, and it's hard to forecast when any of those events are going to come to fruition. And what you always trying to do is there's 35 names, generally in the oil and gas space. They're going to go up and down with the commodity, but you're trying to identify what are five names, who are doing something different operationally, and perhaps avoid the five names that are, you know, more centric risk here that if the commodity price does drop, they are over-leveraged or the well results are deteriorating. And if you can just avoid those five names and pick up five names on the other side, you can generally do quite well here in the sector. And so that's effectively what we're focusing on. But then there's a bunch of other factors that go into this. I may be able to identify. Five names who are doing something different on the well results, they're getting much better exploration success. But if the market doesn't appreciate that when do they, and you're trying to understand the sentiment and the interest in the sector. And so one of the things that we do a lot is just trying to understand psychology. And so one chart that I always typically do is what oil and gas stocks get typed into a Bloomberg terminal relative to other TSX listed stocks. And despite oil and gas or despite WTI prices up, call it 25 - 30% here since July 1st, you actually haven't seen Bloomberg or oil and gas tickers being typed into Bloomberg terminals really much. More than we saw back in July, and we're still a long ways off from the highs that we saw last year back in June, which tells me there's still a lot of guys on the sidelines here. And this price run has really caught a lot of guys offside. And yes, stocks have moved, but it seems like there's still a lot more to go just given how little interest people are still typing in these tickers here into the Bloomberg terminal.

Chris Cooksey: Right. I find it weird that when people I'm talking with my friends or family or whatever and we're talking about how expensive everything is, no one is mentioning oil and gas really, or gas prices or anything like that. I guess everything else has gone up so much. Oil and gas has a little room to catch up there almost.

Jeremy McCrea: Yeah. I think there is some definite room to catch up here, you know 2022 - 2023 was year of the debt repayment. What you're going to see here for 2024 is year of buybacks and year of contemplating more additional growth. And the reason why I talk about additional growth is because we do this other study that looks at change in institutional fund ownership and basically looks at every institutional fund that has ever owned a Canadian E&P over the last five years. What are those funds doing? And this is looking at Canadian funds, US funds overseas, and the biggest buyers of Canadian oil and gas companies right now have actually been US operators. They've probably bought about 95% of all the additional buying that's come into the sector. And, Canadian funds have been net sellers ironically, but it's these US funds that are coming in on mass and one of the biggest. Things that's changing in the US is if you look at the Haynesville, the Permian, the Eagleford, these are the big growth plays out of the US, but there's more and more studies being done that shows that the inventory in those areas is really becoming more and more depleted. You probably only have 5, 6, 7 years, but it's so much so that you are going from your tier one inventory and looking at tier two, tier three inventory, which is including in that, and you can see the well productivity. Continues to get lower and lower and lower and you're seeing a result, the rig counts fall off here as well too.

So despite higher oil prices, you're seeing a real slowdown in this, and this is why you're seeing a lot of these US investors now look up into Canada and saying, What do we have up here, here in terms of the growth and when you look at the evolution that you're seeing in the Moy with frack designs and how these multilateral well designs are opening up all these heavy oil plays in the Clearwater and these stacked other heavy oil plays, it really is opening up a new land rush in terms of you know, the companies that have this, and that's where typically where you see the multiple first, but right now you probably have that multiple expansion and the improvement in the commodity price that are both helping move up these share prices here for Canadian oil and gas.

Chris Cooksey: So the institutional buyers are coming in from the US basically. Is that, is that fair?

Jeremy McCrea: Yeah, that's fair.

Chris Cooksey: Okay. And as we move into the, into the last quarter and into 2024 you expect the trends we've spoken about, you expect them to continue?

Jeremy McCrea: There's no reason why it should change here right now. As I think part of the Saudi's strategy here is I think they're also looking at the same data that we're seeing and seeing the slowdown for the Permian, like these big growth plays and saying, you know, even if we increase commodity prices, I don't think these US operators have the will or the ability to you know, add additional production. You know, the Dallas Fed always does a survey every quarter, and one of the questions that they asked here recently was, with higher commodity prices, why haven't you added more growth? And they give a bunch of reasons. And you know, supply chain was, you know, number one, but shortly behind it was maturing asset base and we don't have any inventory. And so I think the Saudis see that saying, you know what, we can probably cut production because last time we did this in 2024, or you know, back in, you know, the prior decade. Every time they cut the US would just say, oh, let's add more rigs and add more production, and it would negate all those cuts. But now the Saudi’s are sayimg, we can cut, we can dictate where we want that price, and the US really can't do anything about it. And so you've seen them say, And, and take a stand here saying, you know what? We want prices up at, you know, $90 here effectively, if not higher. And we have the ability to control that and no one can do anything about it.

So that's part one. And then part two, you got TMX expansion here, that they're going to start their line fill here pretty soon, which is going to take a lot of, you know, excess de demand out of Canada here, which really should narrow that oil heavy oil differential that we've been having in Canada for the last year. And so the combination of a narrow differential higher WTI prices then add a weak Canadian dollar and you're at $115 light oil Canadian prices, which is two times more than what we saw for the last seven years here. So it is really working well here for Canadian oil and gas companies. And I just think some of these nuances that have all come together here in the last month still aren't fully appreciated by, you know, the bigger generalist investors.

Chris Cooksey: Interesting times as always, Jeremy. I would like to thank you for your time today. Always great insights. And to the listeners out there Jeremy is a regular poster on Twitter and LinkedIn, so give him a follow for more insights and with that Jeremy, I look to have forward to having you back in the future, thanks very much.

Jeremy McCrea: Yeah, thank you. It's Jeremy McCrae CFA, if anybody's looking for my handle.

Chris Cooksey: Beautiful. Reach out to us at the advantageinvestorpod@raymondjames.ca. Subscribe to the Advantaged Investor on Apple, Spotify, or wherever you get your podcast. Please contact your advisor with any questions you have. On behalf of Raymond James and the Advantage Investor, thank you for taking the time to listen today. Until next time, stay well.

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