Energy stocks are down this year. But the bullish case is very much alive
Count Canadian energy stocks among this year’s biggest disappointments. Strong demand for oil amid limited production was supposed to keep crude prices elevated, rewarding investors with soaring share prices and gushing dividends.
Crude oil isn’t playing along, though. The price of West Texas Intermediate, a U.S. benchmark, briefly dipped below US$70 a barrel this week, bringing the total decline to more than 40 per cent over the past 11 months.
The decline is weighing on Canadian energy stocks, which are down 7 per cent this year. Despite Friday’s rebound, the sector is the worst performer in the S&P/TSX Composite Index in 2023.
But the bullish case for owning energy stocks is still persuasive.
The weak stretch follows aggressive interest-rate hikes by the world’s major central banks, which is raising concerns about the health of the global economy. The U.S. Federal Reserve and the European Central Bank raised their respective rates again this week, reinforcing the idea that even a potential recession won’t stand in the way as they battle inflation.
“Oil markets are taking notice of the potential slowdown in domestic demand, but also global demand as a whole,” said Marc Ercolao, an economist at Toronto-Dominion Bank.
He believes the energy market is being driven partly by speculative behaviour, as panic-stricken commodity traders react to deteriorating economic activity and the U.S. banking crisis that emerged in March with the failure of Silicon Valley Bank.
Speculators could be on to something here, of course. Goldman Sachs this week said that a U.S. recession was becoming more likely as bank lending contracts, which is surely bad news for oil demand.
As well, the upbeat U.S. employment report for April, released Friday, could complicate the Fed’s next decision on interest rates. Though the Fed signalled a pause in its rate-hiking campaign this week, additional increases can’t be ruled out.
Nonetheless, the dip in energy stocks this year, to a range between US$70 and US$80 a barrel, suggests that the commodity is caught in a period of uncertainty, which could be rewarding for investors if demand holds up.
“It’s trying to find a direction now, and we think that direction is slowly moving upwards through the end of the year,” Mr. Ercolao said.
There are two key reasons for that forecast.
China’s economy, still recovering from pandemic shutdowns, should bounce back over the second half of this year, adding to demand for energy sources.
Secondly, the Organization of the Petroleum Exporting Countries, with Russia, announced production cuts in April amounting to 1.6 million barrels of oil by July – or 1 to 2 per cent of global demand. The cuts bolster the view that Saudi Arabia will support the price of oil when it falls below US$80.
Usually, the economy slows, demand for oil decreases and oil prices decline – sometimes sharply. But OPEC appears keen to trim output before demand takes a hit, according to Chris Burton, head of the commodities team at Credit Suisse Asset Management and a portfolio manager.
“Quicker production cuts might mean a less drastic price reduction than what we have seen in the past when economic activity slows,” Mr. Burton said.
Even with oil stuck in a lower trading range, large producers are generating impressive profits. Chevron Corp. last month reported a first-quarter profit of US$6.6-billion, up from US$6.3-billion in the same period last year.
This week, Canadian Natural Resources Ltd. reported a profit of $1.8-billion, down from $3.1-billion last year but in line with analysts’ expectations. And, dividend investors, take note: The producer said it can realistically reduce its net debt to $10-billion by the end of the year. At that point, the company has committed to return to shareholders 100 per cent of its free cash flow – $1.4-billion in the first quarter – which implies significant dividend hikes and share buybacks next year.
Suncor Energy Inc. will report its first-quarter financial results on May 8.
“Even with lower oil prices, there is still a high level of profitability here and a good focus on shareholder returns,” said Patrick O’Rourke, an analyst at ATB Capital Markets, referring to the energy sector in general.
The completion of the Trans Mountain pipeline expansion project, which will increase the amount of oil shipped from Alberta to the B.C. coast for export, only bolsters the long-term attractiveness of the sector, he added.
The argument in favour of buying energy stocks in hopes of high oil prices and muted production growth has clearly stalled this year.