Canadian Small-cap Model Portfolio Energy
We are removing our position in NuVista Energy Ltd. (NVA-T, portfolio weight 2.6%).
The removal of NuVista follows our previous reductions late last year, as natural gas continues to come under pressure. With prices 61.6% below the August 2022 peak, including the precipitous drop of 16.9% through the early part of 2023, year-over-year prices have now turned negative for the first time since 2020 (Exhibit 1). We believe that price declines could continue through the seasonally weak winter period (Exhibit 2), as warmer-than-expected weather and the recent inversion of the futures curve back into contango (i.e. loosening supplies, Exhibit 3) could also keep prices depressed in the coming months.
Quantitatively, the setup for natural-gas equities is poor, with the closest contract trading 30.6% below the consensus estimate (Exhibit 4). We would expect this to converge in the coming weeks. Given our more cautious view on natural gas, we would expect to see lower price assumptions and, in turn, lower cashflow estimates for the producers, rather than a recovery in prices.
Within the energy sector, we continue to prefer services over the producers and hold positions in both CES Energy Solutions Corp. (CEU-T, portfolio weight 4.2%) and Precision Drilling Corp. (PD-T, portfolio weight 2.7%). As we show in Exhibit 5, relative strength within the energy sector often rotates to services from producers once WTI oil prices stop rising. Although WTI oil is now down 40% from the June 2022 peak, we do not expect a collapse (i.e., 2020, 2015 and 2008) and we believe that prices should remain elevated. In this scenario, services will likely continue to lead, like we saw through 2010-2013. We presently maintain a near market weight within the services sub-sector at 6.9%, compared with 7.4% for the S&P/TSX Small Cap Index.
With the removal of NuVista, our E&P exposure is through our lone holding in Enerplus Corp. (ERF-T, portfolio weight 2.6%). Given our preference for services over producers, we are well below the S&P/TSX Small Cap Index weighting of 9.4%. We believe that the E&P sub-sector is presently trading too high relative to WTI oil and unless we see a positive breakout in oil from its weak technical price channel of lower highs and lower lows, we believe that the equities will get pulled lower (Exhibit 6).