Why oil is an 'incredibly target rich environment to create alpha'

Energy fund manager explains why he doesn't expect alternatives to replace oil in his lifetime

Why oil is an 'incredibly target rich environment to create alpha'

Eric Nuttall, Partner and Senior Portfolio Manager at Ninepoint Partners LP, is betting on oil being a staple for his lifetime, even as the players start to move to net zero emission to address climate change.

That’s good news for Nuttall, who manages the 16-year-old Ninepoint Energy Fund. But, he said there’s a real lack of knowledge about how oil is used – and the likely timeline for alternatives to displace oil.

“Let’s look at how oil is used,” he told Wealth Professional. “60% is transportation; 40% is not. Transportation is the low-hanging fruit. When you talk about electric cars, that’s 27% of oil demand. There are 1.3 billion internal combustion engines to displace. That number continues to grow as the world’s population grows and living standards rise. Last year, electric car sales were five million and it will be ramping up. But, how quickly does have million per annum have to scale to displace 1.3 billion?

“The other thing is heavy hauling trucks, which will have to use hydrogen instead of oil. Well, you’re looking at the mid-2040s before you can produce enough hydrogen for them. That will require hundreds of billions of dollars of investment to displace global diesel.

“And there’s jet fuel at eight million barrels per day. They’re talking about renewable jet fuel that uses cow tallow and algae and a while bunch of wonderful things. It’s not profitable and, even if it was, you’re looking at a timeline measured in decades. So, that’s the easy stuff: that’s 60% of oil demand. You don’t reach critical mass until at least two decades from now.

“The other 40% are things like petrochemicals, plastics, lubricants, cement, agriculture – and all of those things grow as the world’s population grows. The challenge with that is the global population is going to grow by over two billion people between now and 2050, and we’re supposed to hit net zero. The only way you can do that is by lowering your living standards because the higher the living standard, the more we consume.

"The average person in North American consumes over 20 barrels; the average person in the world consumes five barrels every year. So, as global living standards are rising, and populations are growing, that oil intensity is rising, it is not falling. Only the most energy ignorant could think that we will not be using oil for the foreseeable future. You and I will be using oil for the rest of our lifetimes.”

The good news for Ninepoint and Nuttall is that will give their Ninepoint Energy Fund a much longer run. While there were many such funds when it launched in 2005, there now are only two, and Nuttall noted “this has been a challenging, challenging sector for awhile".

But, he believes oil prices could reach $100 a barrel by the end of this year, and he’s expecting all-time high oil prices to follow that, so he admits that he has a bullish outlook. He added that, in a pre-pandemic interview, he said that while he didn't know when things would turn, he was buying stocks that he thought could go up by 400% or more. One year later they were up 420%. "I try to find multi-baggers in the Canadian energy sector today," he said, "even though stocks have done very well.”

Ninepoint has watched its fund ride all of the recent volatility, with the rise and fall of U.S. shale, OPEC’s strategy pivots, and prices that have bounced from $100 to negative $40. It dropped 70% at the beginning of the pandemic, but then it quadrupled to $1.1 billion. There are promises of more growth to come as demand outstrips supply.

“We only have two energy funds left in Canada. Everyone else is either converted into an ESG fund or left the business,” he said, noting that even the banks got out of it. “What that means is it’s an incredibly inefficient market. The garbage is being valued the same as the quality. So, for a guy who’s willing to spend the time and put in the effort, it’s an incredibly target rich environment to create a lot of alpha.”