Are the clouds of energy ignorance lifting? Listen in as Eric Nuttall tells Hainsworthtv why high gas prices aren’t going away once the Ukraine Russia War is over and the political class needs to understand the solutions. Listen to the full podcast.
So the pain at the pumps isn’t going away for years?
We look around the world and I feel pretty confident about at least 10 years of oil demand growth. To boil it down, I can't tell you where the necessary barrels are going to come from today. U.S Shale's got a couple more years of meaningful growth and then it's done. Canada, we can't grow oil production because investor constraints, but we've got pipeline constraints and a government that's not its biggest champion. So, we are very, very simply in an energy supply crisis with no easy fix. And so, it's going to, I think, result in a environment of sustainably high oil prices.
The Alt Thinking Podcast by Ninepoint Partners begins now. Here is Michael Hainsworth.
Russia’s attack on Ukraine was also an attack on our wallets. As prices at the pumps spiked, world leaders looked for alternative sources of crude as the sanctions against Putin’s regime grew. Canada has the world’s third largest oil reserves, yet the United States is turning to Venezuela and Iran for incremental barrels. Pipeline politics aside, this is bearish for motorists but bullish for investors in the sector. Eric Nuttall says this is the most bullish environment for oil in modern history as OPEC’s spare capacity is exhausted and we have no safety buffer with record-low inventories. So I asked him: are the clouds of energy ignorance finally beginning to part?
I'm certainly hoping. I'm hoping this is a teachable moment, what we're going through. Not just in Europe but also in the United States and Canada, where I think politicians are realizing that vilifying a sector that provides a necessary commodity that allows their way of life and will for the rest of our lifetimes, perhaps vilifying that and not encouraging production growth was perhaps not good energy policy.
And so, the thought of Biden shunning Canada but now going to Iran and Venezuela begging for more barrels so that he doesn't get voted out of office in the midterms this November, my hope is, is a teachable moment, not just for them to potentially prioritize Keystone once again and allow the most ethical barrel produced in the planet to be shipped to them so that they could get off their 600,000 barrels per day of Russian imports.
But also in Canada, we are so blessed with an abundance of hydrocarbons, whether it's clean, burning natural gas, ethically produced oil, and there's a global call on those commodities. And all Canadians benefit. Like I'm here sitting in Toronto, but everybody benefits. It's not just an Alberta thing. The royalties, the cash taxes, given how profitable the sector is and the cash taxes that all energy companies will be paying, those go not just to the provincial government but the feds.
And so, it allows us to increase our military spinning and protect us, it allows for schools to be built, it allows for hospitals to be built, for roads to be built, et cetera. And so, it's a national treasure. And my hope is that we are starting to realize that and place more importance on it rather than just vilifying it.
So then, what is the solution from that policy maker perspective?
Well, the solution is to abolish any existing legislation that disallows meaningful production growth. And so, there is legislation like Bill C-48 and 69, which basically makes it impossible to build another pipeline, a new pipeline in Canada, tanker bands, et cetera, and just not attacking industry. Just getting out of its way.
I've got a soft spot, of course. But oil companies, they're extremely entrepreneurial, hardworking, salt of the earth, it's just get out of the way in terms of any bureaucratic measures that stymies growth, stymies investment. It's that simple.
But you can't expect to see a substantial backpedaling on policy to make that sort of thing happen.
Well, I think people need to realize we need an all of the above solution. We need to decarbonize. We need to lower emissions' intensity. And we are. It's just, it's going to take a lot longer than what the average person believes. So, between the here, here we are today and then, which is measured in decades, there's a global call on hydrocarbons for natural gas as a baseload for alternatives.
I think we're seeing in UK where their energy prices went up by 20 or 30 axis. The wind didn't blow and the sun didn't shine. You basically die without energy access, at least in Canada. And so, natural gas is going to serve as baseload power for decades and decades and decades to come for oil. We will all be consuming oil for the rest of our lifetimes.
And so, it's a very simple question. Where do you want that oil to come from? Do you want it to come from Russia where they sell oil, they get revenue from it and they go and buy cruise missiles and kill innocent kids, or do you want that revenue rather to flow into Canada where we produce the most ethical barrel in the world, one of the cleanest barrels in the world? It truly is that simple.
So then, to what do you attribute the Americans turning south to Venezuela, turning east to Iran to offset almost all of the Russian export losses?
Yeah. So, we know that there's a midterm election coming up later this year. Inflation is a massive problem for the Biden administration. One of the greatest inverse correlations to presidential approval ratings is the gasoline price. And so, on Twitter, I just put up a photo of a guy who put a padlock on his gas tanks that nobody could siphon it off. It's a big, big, big problem.
And so, Canada, I think there's a call for crude by rail. We could get that going. We could ramp up production, even though our own inventories are low as they're in the U.S and as they are globally. And so, the shorter term fix, I can see where they need a win desperately. They need a win. But here we have this morning announcement that the Iranian negotiations have been put on ice for an undetermined amount of time.
Venezuela, my God, they only need about $85 billion to restore productive capacity there in many, many years as there's been a brain drain, subsurface damage, looting, pillaging above surface, et cetera. So, there's no easy fix. There's no easy fix to what's happening in Russia/Ukraine where I've got a note this morning from Energy Aspects saying that Russia is going to have to decrease exports by 3 million barrels per day because their storage is literally filling and it's no longer politically palatable to buy barrels from them, and defacto, be arming them.
And so, the punchline here is there's no easy fix. I think oil is going up higher and it's going up meaningfully higher. And the only way to balance the market is to rationalize discretionary demand. We have to kill demand with much, much, much higher oil prices. If we look at inventories are falling when they need to be building. The U.S, we just drew, I think it was 13 million barrels of oil and products this week when it should be building. We're in winter time.
We've got the summer driving season coming ahead and we're at multi, multi multi-year low levels. People still do not appreciate the fundamental backdrop for oil. I think the average person probably thinks, "Well, geez, Ukraine and peace breaks out, the oil prices are going to collapse by 20 bucks." This is the tightest oil market that I believe anybody has ever seen in their lifetimes.
I think you had written that we've reached the most bullish event for oil in modern history.
Yeah. So, that's the exhaustion of OPEC’s spare capacity coming in the next couple of months. There was a call from the Biden administration supposedly wanting to go kiss the ring and go to Saudi Arabia and effectively dig for more oil. They got turned down. The fact that we even know that and that it didn't happen behind closed doors or behind the curtain, so to speak, is telling into it unto itself.
And so, when we look at OPEC, they've been dealing with a subpar oil price for the past six, seven years where you're a Petro nation, oil revenue is 60%, 70%, 80% of your state revenue. Therefore, it's also 60%, 70%, 80% of your state expenses. And in these nations, you've got a social contract with your populace. You subsidize power, subsidize jobs, subsidize education, et cetera.
And the flip side to that is the populace doesn't go out into the streets and revolt because it's not like in a democracy like Canada where you just get voted out of office. In some of those countries, the consequence could be much, much, much more severe for the ruler. And so, you do not cut social spending. What you do cut is investment in productive capacity, because we're talking about production in the future corresponding with a low oil price environment at the time.
And so, when about 75% of OPEC is currently under-producing their quota forsaking hundreds of millions of dollars, why are they doing that? It's not benevolence. It's because they haven't been investing enough and their productive capacity has fallen. And so, I think OPEC is out of spare capacity in the coming months. That has been the historical shock absorber for any geopolitical event like Russia, Ukraine, where we're removing millions of barrels per day off of the market with demand at all time highs right now.
And so, that's extremely bullish. The end of U.S shale hypergrowth was a massively bullish event for the energy sector. The exhaustion of OPEC's square capacity, in my opinion, is going to be even more bullish.
You said something interesting back there. And I'd like to come back to it because when you are the kind of analyst that you are, you also have to be a geopolitical scientist as well. So, why do you say it's telling that America went to Saudi Arabia to kiss the ring and we knew about it?
Well, they tried to and it got rejected. And so, I would quote or I'd cite one of my, the gentleman who shaped in terms of how he had analyzed the oil markets and that's Mike Rothman of Cornerstone Analytics. He was the one who taught me to follow inventories as closely as we do.
His opinion is there was a strategic shift within the U.S away from Saudi Arabia and towards Iran after 9/11. And so, the ability of the U.S president just to call up, dangle some arms sales in front of their nose and then hope that you get an immediate response from production isn't quite the same as it would have been several decades ago.
So, there's likely been a strategic pivot there in terms of allegiances. And so, I don't think you're going to see an unraveling of the OPEC+ deal and getting a surge in U.S supply. OPEC is allowing barrels to be pulled from them. They're not pushing barrels onto the market. That's a very, very important distinction because it means that OPEC is going to be very cautious, they're not going to prematurely add barrels until they're extraordinarily confident that they could easily be absorbed.
They've successfully drawn down inventories back to the 2010 to 2014 level. Why the heck is that important? That's when oil averaged a hundred dollars, that also happens to be the fiscal break even for many countries within OPEC.
And so, we may think we're staring at $105 oil, and geez, that's a high oil price. We are just back to where most OPEC countries are viable going concerns.
What's the ceiling on the price of a barrel, do you see?
It's a really good question and it's something that I'm trying to find an answer to. My honest answer is nobody in the world knows. Because we've never had a playbook to reference for the environment that we have now. And so, what do I mean by that? The last period of time when oil demand was impacted, there was always another event, the financial crisis '08/'09.
You could say, "Well, the burden on the global economy, we reached about 5% of global GDP being spent on oil, therefore it was too much and you saw a demand collapse." But at the same time, we went through the financial crisis and oil was sold off as a financial vehicle because the oil contract's been very much financialized.
If we go back to the '70s, the oil intensity per unit of GDP today is down 75% from then, meaning that would naturally imply a much higher oil price to kill demand. And so, I'm trying to figure that answer out, so is many other people. It feels like we're talking about 150, but I'm going to reserve the right to change my mind. It's not 130. It's certainly not 105.
For the average guy who doesn't own energy stocks, obviously it sucks that you pull up to the pump and you're like, "Geez, this is just crazy," but it's not painful enough to change behavior. And so, you need it to go high enough for people to say, "I'm sorry, kids, but we can't fly to Florida. We can't go into Disneyland this year. It's too expensive. We can't go on that road trip in the big gas RV." We need to get to that point.
And so, that was always my thesis. The multi-year bull market thesis did not require geopolitics. It didn't require humanitarian crisis like we're seeing in Ukraine. It simply boils down to four main things; demand's going to grow, I think, for the next 10, 15 plus years, at which point it will only slowly fall. We're in the end of U.S Shale hypergrowth. U.S Shale is going to grow probably by a million barrels per day this year. Thank God it will because we really need those barrels.
OPEC's out of spare capacity. And if they want to increase that, it's going to take them four to six years. And the global super majors, they stop spending in 2014, investments collapsed. We're seeing oil price go up and investment is not because they need to reach decarbonization goals, invest more in solar wind, pay down debt, pay dividends, et cetera.
And so, those are the four simple ingredients to why we're in a multi-year bull market. And those four parameters were always going to lead, in my opinion, to an all time higher oil price. What we're seeing in Russia/Ukraine by removing several million barrels pretty off the market, it's just fast-forwarded what I thought was an inevitability. So, here we are today.
You've been a strong proponent over the course of the last 18 months, and I'm sure beyond, of the energy majors taking that cash that they've got coming in the door, buying back their shares, boosting their dividends. What do you expect to see with crude at $130, $150 oil for a sustained period like what we're seeing right now?
Yeah. So, even using $100, we are obviously in a golden era of free cash flow. The average selling price for a Canadian oil producer has never been higher in history because the last time we were at $100, $105, the loony was a lot higher. And so, that relationship is broken.
And so, the realized price in Canadian dollars per barrel of oil is awesome. Cost structures are low because this industry has had to live through the worst bear market in history, so they've cut to the bone and they've not been adding to the CapEx line.
I know you've got guys like me, which we run the biggest energy fund in Canada and I own multiple small and midcap stocks where we've got a meaningful position. So, in a very friendly way, we've got an important seat at the table in discussing strategy. And my view is, you cannot justify growth given that stocks are trading at such unbelievably low valuations like $100 oil.
I'm in the market right now buying a stock that I think is trading at 1.5 times cashflow when they have more than 20 years of inventory to keep their production flat. So, I'm not paying for 18 and a half years of cash flow of which they could probably pay a 25% to 30% dividend from that.
And so, how can that company justify growth when what they should be doing is keeping production flat, maximizing free cash flow and then distributing that back to shareholders first with buybacks? And then ultimately, I think we're going to get a rerating in valuations closer to historical averages at which point the pivot will be from buybacks to dividends.
And so, the ability for Canadian energy companies, forget 150, this is true even at 80. You could pay such massive dividend yields that that will act, I think, as a catalyst, as will buybacks, to wake people up to the generational opportunity in energy stocks. I have never seen stocks trade as cheaply as they are and yet the macro backdrop for oil has never been better than what it is today.
What though of the end game at $130, $150 oil? When we talk about demanded and destruction, at what point do the wallet snap shut?
Yep. So, the market's going to have to find balance through trying to incentivize supply growth. U.S Shale, we think they can grow by a million barrels per day per year for the next two-ish years, at which point they reach peak and that starts to fall. We need to encourage long cycle investments. So, those are the big offshore projects that take four to six years to come online.
OPEC will assuredly start to increase their own capacity. We're talking years. So, we're in this environment, this multi-year period. And I don't know with precision the answer today, but we as sure as heck are going to be paying close attention and navigating it. But the end game is the market's got to balance through encouraging more supply growth and killing demand. And you're going to find balance because we're up multi year low levels for global inventories. We are in real danger right now.
We've been writing about we're in a supply crisis and I think more and more people are waking up to that. And so, I think we're going to assure, I think, be in $100 plus price environment. I don't want to say we're going to be hanging at $150 for the next five years, but I think we're looking at triple digits.
And once people realize that that's a sustainable level, the average Canadian company at $100 oil can privatize and become debt free with 3.2 years of free cashflow. And yet they're sitting on average 15 years of state flood inventory.
That's such an unbelievable bust. And it goes back to the theme that we touched on, energy ignorance. The average person does not understand how oil is used and how many decades it's going to take to displace its usage.
Once people do, then you can start putting value on long dated reserves. And so, we have holdings where they have 30, 40, 50 years of reserves, and I'm paying for three of them. So, how can you not get excited at that opportunity?
I'm going to ask you to pull back a little bit from the microphone because I'm starting to get a little popping as well. So then, on the topic of energy ignorance, this is more of the dinner party question, which in mid-COVID, are we even having dinner parties yet? But explain then that relationship. As people go, "Wait a minute, oil was a hundred bucks several years ago but I wasn't paying this at the gas pumps. What's going on and how much longer am I going to feel this pain?"
I think the pain will be felt for as long as-
Can you pull back again? Sorry. I'm getting poppings on your piece.
Is that better?
Ish. It's now a little more echo-y.
Well, I'm three feet away.
Oh, yeah. No, no, no. You can still hold it up to yourself, but talk past your phone as opposed to into your phone.
Oh, I see. Okay.
So, the pain is going to last so long as people remain underweight energy stocks. I do the happy dance whenever I fill up because I know that my fund is doing significantly better than what I'm having to incrementally spend on gasoline. But I don't see the pain ending for the average person. There will be profound economic shocks from this, given that oil's the biggest commodity in the world and it has input. The input cost is in literally everything that we use or consume.
And so, I'm not the guy to ask about, okay, what's the broader economic read? But my own take, I do not see how a happy ending for the average person comes from this. My job is to really segregate that from, how do I make my unit holders the most that I possibly can from the environment that we've been predicting for years and now we are living in?
And so, again, the only fix to a structural supply challenge is for the oil price to go high enough to allow for the global super majors to pivot away from meaningfully investing in ESG, investing in really horrible, low margin offshore wind projects and solar, et cetera, and will allow them to increase investment in long cycle offshore oil projects.
But again, that's cycle time. We're four to six years. And so, to answer your question as best as I can, how long is the pain? How long is the sticker shock going to last? I think we're in a multiyear period of sustainably high oil prices.
If peace breaks out, do you see Russian oil coming back online or have we decided we don't want to have it ever?
I think there's a taint that will last for years. When you have the global super majors like Exxon, BP, Shell, God, I'm missing others, but they've all pulled out. They're taking meaningful asset writedowns, the Russian government's threatening to nationalize their interests and projects. They are not going back anytime soon.
And so, yes, China may increase investment, et cetera, but you don't have the technological know-how, the expertise. You don't have the service sector that's going to be operating in your country. And so, I do think there is a significant long term impact from this.
There were already stories in December of last year talking about how Russia may have been reaching maximum productive capabilities. A lot of the projects, et cetera, are very, very long in the tooth, been producing for a long time just like a lot of OPEC.
And so, maybe the pullout of foreign capital is, again, going to accelerate, or at least cement in that reality. So, we look around the world and I feel pretty confident about at least 10 years of oil demand growth. To boil it down, I can't tell you where the necessary barrels are going to come from today. U.S Shale's got a couple more years of meaningful growth and then it's done. Canada, we can't grow oil production because investor constraints, but we've got pipeline constraints and a government that's not its biggest champion.
And yes, while there are pockets in the world like at Guyana where production is growing, it's falling in a lot more other areas than where it's growing. So, we are very, very simply in an energy supply crisis with no easy fix. And so, it's going to, I think, result in a environment of sustainably high oil prices.
In April, the Canadian government's expected to announce the spring budgets. You're anticipating several items related to the oil and gas sector?
I am now. What we've seen in the past couple of days, they're starting to walk that back a little. So, the notion of an emissions cap product, which is a defacto production cap, let's be real. That's been pushed off until early 2023 supposedly by our environmental minister who's famous for having climbed the CN Tower to protest against oil and gas.
We're probably looking at some positive initiatives to put a cost on carbon, meaning companies that are injecting CO2 into the ground. Like we have some producers that are net zero emitters because they're literally purchasing, they're buying CO2 using that to keep production going as a pressure maintenance scheme.
And so, I think they could potentially get credit for that, so that would be a positive for the companies. But what I'm hoping is, the government's being given a golden opportunity to pivot a little away from prior proposed initiatives that would put a cap on our sector in a world where the world desperately needs more Canadian energy. It needs more Canadian oil, it needs more Canadian gas.
And the reasons for that should be abundantly obvious. We need to displace market share from those who are committing atrocities. That is, find me a person on the planet that can dispute that. And so yes, we need to decarbonize. Yes, we need to continue to lower emissions' intensity. Yes, we need to do more on methane emissions and inventing, et cetera. But Canada has the highest environmental standards of any country in the world. If the world needs a barrel of oil, let it be a Canadian barrel.
And I hope that message is resonating with the key decision makers ahead of the budget in the next couple of months.
Eric, this has been fascinating analysis. Thank you for that. And by the way, congrats on the launch of the Ninepoint Energy Income Fund ETF.
Thank you very much. We couldn't script a better environment to be launching an energy income fund. It's the combination of record high oil prices, at least for Canadian guys, very good for U.S, lean cost structures, moderate growth, maximum free cash flow, a commitment to dividends, both initiating them and growing them.
And plus, what we're doing is it's an incredibly inefficient market where very few people have the know-how to model out a company and say, "Well, geez, what could they pay in a variable dividend at $89, $100, $110 et cetera?" And so, we have companies where $100 oil, we think, will be making a 8%, 9%, 10% dividend yield from them.
And then at the same time, where this is no longer forecast. We've actually written calls on 30% of our fund three different positions where we're making annualized yields of 15% to 30%.
So, you combine that with a 10% cash dividend yield and it's glorious. So, we've set the bar low, our initial payout is 5% per month. We want to walk before we run. I always tell my management teams to set the bar of expectations low and always beat it. We're practicing. We think that the same philosophy, but for somebody looking to take advantage of our skillset at stock picking, which we've done an okay job at, like we ran the number one energy fund in the world last year, we can combine that with an environment that is extremely conducive to free cashflow, therefore dividends, and then also taking advantage of the volatility embedded in the options market by writing calls and getting paid a lot for that.
And so, I'm really, really excited about this. And we had a great launch. We had New Exchange describe it as one of the most successful launches of an ETF series in Canadian history. And so, I think the value add that we're bringing to the table is being recognized by investors.
Thanks very much.
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