Portfolio manager explains how a broad energy strategy can pay off in the short and long term
Last week, when news of “GLOPEC” abounded, and it seemed like the world’s major oil producers might all join hands and get prices back up to a level, Rafi Tahmazian sold his oil positions as the price began to rally. He redeployed capital into gas.
The senior portfolio manager at Canoe Financial explained that with the cratering of demand, production has cratered as well. He noted that gas production over recent years had transitioned from producing gas as the main product, with by-products like condensate as a value-add, to producing condensate first because of its ability to liquify unconventional sources of oil like the bitumen sands in Alberta. “Dry” gas became a by-product.
Collapsing oil prices meant collapsing oil production, which meant a collapse in a gas production that was largely serving oil producers. Demand for gas, however, isn’t being hit the same way oil is. People aren’t travelling, but they still need to cook and heat their homes. Some of Tahmazian’s gas producing investments are hitting close to or above their annual highs off the back of the oil price collapse. Moves like these are a part of Tahmazian’s subsector approach to energy. That approach looks at oil as just one subsector, one that plays against other subsectors.
“We did that because we analyze the sector by subsector,” Tahmazian explained. “Everybody thinks of energy as a subsector of the broader market but for me, my life is oil, my life is energy so we look at energy as having nine subsectors.”
Tahmazian broke down the subsectors as conventional oil, unconventional oil (shale, bitumen etc.), gas, mid-stream companies, downstream companies (including pipelines and rail infrastructure), the energy service sector, renewable and sustainable producers, “other” (including petrochemicals), and cash.
“This allows us to eliminate the need to invest in higher-risk names,” Tahmazian said. “Because if I like gas, I don't go out and buy the most risky gas stock, I'm buying the concept that the gas sector is looking good. I can just gravitate to the best companies in the subsector. Because my call might be wrong too and, if I'm wrong, I don't want to own the riskiest names."
While gas seems a strong performer in the short term, Tahmazian painted a bleak picture of the short term for other energy subsectors. He thinks the energy service sector will be “annihilated", but this cull will set up a stronger industry as the small core of surviving companies will be able to exercise massive control over the price of services in a post-COVID world.
The forces affecting the conventional and unconventional oil sectors are deeply complex, but don’t bode well in the short term. Tahmazian saw the speed of the collapse in oil demand as “unfathomable", it’s been followed by a collapse in oil supply as operations shut down across the globe. Restarting that supply won’t be as simple as turning on a tap, either.
Tahmazian isn’t too optimistic about short-term restarts to demand. He said it was unlikely that the airline industry or auto industries will recover quickly to create a “V’ shaped recovery in the oil subsectors. He does have some hope for infrastructure spending, both conventional and tied to healthcare. He’s already seen huge spikes in infrastructure development in China, which has largely passed the peak of its own outbreak. Beyond the short term, he sees opportunities arising in oil.
“Because the market did not differentiate good from bad companies when the sell-off occurred, you can own the best-in-class names within those subsectors,” Tahmazian said. “Over a period of three to five years, which I think is not an unreasonable expectation for the market to become more normalized again, there is a 300 to 500% return.”
As with his subsector approach, Tahmazian couched that promised return in advocacy for a knowledgeable asset manager. He doesn’t necessarily think buying and holding one big name will produce those kinds of returns. Key decisions at the right moments will have to be made. Still, he has hopes for a new energy sector emerging from this crisis.
Most of those hopes rest on the collapse of high-cost U.S. shale oil producers. He thinks that since the rise of U.S. oil producers, OPEC has lost its control and the oil market has been truly “free” for the first time since the ‘70s. From a Canadian perspective, Tahmazian wants to see U.S. shale producers collapse and OPEC pick up a controlling market share. With that in hand, he thinks prices can be controlled again, bringing Canada’s energy sector and broader economy back from the brink.
“We want to see the U.S. get hurt by this, their growth severed, and their production truncated,” Tahmazian said. “We want to see bankruptcies, we want to see consolidation and M&A in that industry. That means you get a rebalancing to a much healthier market, and that's healthy for Canada.”