'Don’t swing for the fences' if you want to bet on oil

Portfolio managers don’t see US-Iran tensions sparking long-term price jump and instead back well-capitalized energy firms

'Don’t swing for the fences' if you want to bet on oil

Canadian energy equities have ticked up in the wake of escalating tensions between Iran and the US. However, it will take a lot more upheaval in the Middle East to turn that tension into a fundamental improvement in the state of Canadian energy stocks.

In the wake of the US airstrike that killed Iranian general Qassem Soleimani last Friday, an Iranian promise of “revenge” saw oil prices surge, US equities fall, and gold’s value rise as investors sought safe havens, fearing an escalating conflict that could interrupt the flow of as much as 20% of global oil supply.

Canadian producers saw an immediate stock jump thanks to a higher crude price. According to two portfolio managers, though, that rise is soft and unless tensions continue to escalate and Iran, the US, or another major player makes a move that meaningfully restricts oil supplies from the Middle East, oil prices will fall back to normal levels and Canadian energy equities will follow.

“All that we have so far is tension. There's been no actual restriction on supply, no disruption. People are just nervously anticipating that something could happen,” Les Stelmach, SVP and portfolio manager, Franklin Templeton Canada, told WP. “If ultimately nothing happens or nothing that would disrupt crude oil supply in any meaningful way, then I think we’ll probably just drift back to where we were before Thursday night.”

Stelmach, who is based in Calgary and specializes in the energy industry, saw a broad stabilization of prices before the US airstrike that was gradually improving the outlook for Canadian energy stocks, which have flagged in recent years on the back of low global oil prices. He thinks that for prices to move higher in the long term, tensions would need to result in a meaningful restriction on tanker traffic through the straits of Hormuz, through which roughly 20% of global oil flows.

Chris Stuchberry, a PM at Wellington-Altus Private Wealth and member of the Stuchberry Group, broadly agreed with Stelmach that an unlikely dramatic further escalation would be needed to fundamentally change the Canadian energy equity landscape. He noted that global oil supplies are still growing faster than global consumption, largely driven by technological innovations in regions less susceptible to the kind of instability currently on display in the Middle East.

“I just don't see it yet,” Stuchberry said. “I think that the move in Canadian energy at this juncture remains trading capital … I'm sure the market is predicting ‘there could be a disruption to Iran's production, therefore we should position ourselves accordingly’. That doesn't seem likely to me at this juncture.”

Stuchberry also sees uncertainty on the demand side of the oil market. He mentioned the rising popularity of electric vehicles, ride sharing, and the hopes associated with self-driving cars. All those factors could see demand for oil slip this decade. Though he accepts that rising demand is driven by emerging markets like India and China, he doesn’t think they’ll need to follow the same development model as the West, and go through their own version of the ‘80s where personal vehicle ownership becomes a cultural norm.

If the recent spike in oil prices has peaked your interest, though, and you want to bet on further escalation and more upticks in Canadian energy stocks, Stuchberry and Stelmach both think you should bet on bigger, well-capitalized Canadian energy firms.

Though the potential returns might not be as high as with a smaller, exploration-focused company, those energy firms are less likely to suffer significant downturns. As well, Stelmach noted it would take a meaningful and sustained price rise over a long period of time to kick-start more Canadian exploration, improving prospects for oilfield services firms and the wider energy industry. In the meantime, bet on firms that pay dividends.

“Stick with the well-funded companies … the ones that are actually generating value,” Stelmach said. “I wouldn't be swinging for the fences trying to bet on which name would benefit most from the next $2 movement in oil prices. I would still go with the higher-quality producers that have a budget that was funded with cashflow - those names that have a more uninterrupted track record when it comes to dividend payment.”