The 3 Energy Myths Misleading Investors

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Ninepoint Partners’ contrarian investor on why we’re in a multi-year bull market for energy stocks

DESPITE A backdrop of misconceptions and skepticism, the fundamentals supporting energy companies remain robust. Eric Nuttall, senior portfolio manager at Ninepoint Partners, in a discussion with Wealth Professional, sheds light on why he believes this sector is poised for significant gains and dispels some of the prevailing myths that have clouded investor judgement. The “contrarian investor” notes that many have shied away from the energy sector, opting instead for trendy sectors like technology and artificial intelligence. “It impacts sentiment and leads to a buyer strike. Energy funds in North America have had negative outflows all of this year [and] through much of last as well,” he explains.

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Physical oil demand remains strong

Apr

“Energy remains a contrarian investment because ... many advisors in Canada have no energy or little energy on the books for their clients”

Eric Nuttall, Ninepoint Partners

A significant factor contributing to the undervaluation of energy stocks is the prevalence of false narratives about the oil market. Nuttall identifies three primary misconceptions.

Energy stocks, the fund manager counters, especially in Canada, are top performers yet remain undervalued due to negative sentiment. “Energy remains a contrarian investment because ... many advisors in Canada have no energy or little energy on the books for their clients,” says Nuttall. Despite these challenges, Nuttall remains bullish on the energy sector. He highlights companies like Veren Energy (formerly Crescent Point), Cenovus, and Baytex as particularly promising. These companies have adopted strategies to moderate growth and maximize free cash flow, using this for

It’s clear that investors are flocking to sectors like technology, particularly AI, which has become incredibly trendy. Natural gas producers are anticipating a significant spike in demand over the next decade, driven by a surge in electricity consumption due to the increasing influence of artificial intelligence. This growing demand for electricity is expected to challenge the capacity of renewable energy sources to meet it on their own. Following a decade of stagnant power growth in the US, electricity demand is projected to increase by as much as 20 percent by 2030, according to a Wells Fargo analysis published in April. This trend benefits natural gas, but it also diverts attention away from the energy sector. Nuttall finds it unusual to have strong performance marred by such poor sentiment.

With many companies having reached their debt targets, they can now return 100% of free cash flow to shareholders, potentially doubling the amount of share buybacks and driving further stock price appreciation. “Now we’re at the inflection point of companies returning 100% of free cash flow, you’re essentially going to, in many cases, have a doubling of the quantum of share buybacks,” Nuttall maintains. “The best opportunities remain in Canada,” Nuttall says. Despite trading at depressed valuations, Canadian energy companies have deeper inventory and equally strong balance sheets, and the political risk discount they currently face is expected to ease by the fall of next year once pensions are fully vested. Additionally, Canada has recently improved takeaway capacity for both oil and, soon, natural gas, further enhancing the sector’s potential. “In my opinion, the false narratives surrounding energy stocks are a short-term phenomenon.”

underscores the long-term demand for traditional energy sources like oil and natural gas. “The majority of the world is focused on energy accessibility and energy affordability, not decarbonization,” Nuttall emphasizes. “The supposed transition that we’re experiencing is either not going to happen or it’s going to take much longer than what energy policymakers are telling us. Traditional energy sources, like natural gas, are likely to be major beneficiaries in this prolonged transition period.” There are 2.3 billion people worldwide who rely on wood, dried cow dung, or other animal dung as cooking fuel. This is the energy reality for a significant portion of the global population, which is primarily focused on accessing reliable and affordable energy. These factors drive long-term demand for oil, natural gas, and even coal, as evidenced by the current record demand for coal.

Bullish names in the sector

Published June 24, 2024

“We’ve been huge champions of companies moderating growth, focusing on maximizing free cash flow and using it to meaningfully buy back their shares”

Eric Nuttall, Ninepoint Partners

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Source: Bloomberg, Ninepoint Partners

Source: Flow, March 2024

Shale maturity increasingly evident

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Economic factors driving oil demand

significant share buybacks. “We’ve been huge champions of companies moderating growth, focusing on maximizing free cash flow and using it to meaningfully buy back their shares,” Nuttall states. When it comes to selling stocks, Nuttall bases his decisions on valuations. If a company’s strategy is not aligned with his expectations, or if valuations approach fair value, he considers selling. For instance, Athabasca Oil was sold after it performed exceptionally well, and its valuation no longer justified holding it for only a 10 percent upside. “Athabasca was a name that did very well for our clients ... it just gets to a point where the risk versus reward is no longer there,” Nuttall explains.

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Eric Nuttall began his career in 2003 right after graduating from Carleton University. Having always had a passion for investing, he found breaking into Bay Street challenging, as Carleton wasn’t a prominent name that companies were eager to recruit from at the time. Despite this, he secured a position at Sprott Asset Management, where he worked alongside JF Tardif, gaining his initial industry experience. In 2005, Sprott launched the Sprott Energy Fund, which Nuttall eventually managed. A management buyout in 2017 led to the creation of Ninepoint Partners, where Nuttall continues to manage the fund, now the Ninepoint Energy Fund, as well as an income-focused fund, the Ninepoint Energy Income Fund. Nuttall has earned industry recognition for his steadfast conviction in his thesis and his proactive approach to gathering first-hand insights from around the globe. He currently has over 90,000 followers on Twitter/X (May 2024).

About Eric NuttalL

False narratives plaguing energy sector

The OPEC+ cohesion: Thirdly, Nuttall points out, there are concerns related to OPEC+ and its market strategies. Despite OPEC+ successfully managing the market by reducing output to counter the impact of US Strategic Petroleum Reserve releases, there is a fear that US production growth could provoke OPEC+ to flood the market again to maintain market share. This perceived instability contributes to the negative sentiment toward oil stocks. However, as of January 2024, Saudi Arabian Oil Co., commonly known as Aramco, announced that the Saudi government had instructed it not to increase its oil production capacity. This directive halts plans for the world’s largest crude-oil exporter to expand its production capacity by 2027. This decision comes amid tightening supply and strong demand, which have driven up prices in recent weeks.

Weak oil demand: Firstly, he says there is a belief that short-term oil demand is weak due to fears of an impending recession, driven by high interest rates. Additionally, there is a misconception that medium-term demand for oil will decline, like a sort of “sunset industry,” as electric vehicles (EVs) become more common and environmental measures such as banning plastic straws reduce oil use. Nuttall adds, “Predictions from the International Energy Agency suggest that oil and hydrocarbon demand will peak later this decade. These factors distort perceptions of the fair value of oil and energy companies.”

Surging US shale production: “Second, the unexpected growth in US shale production last year has led to concerns that companies are repeating past mistakes,” Nuttall says. “Despite promises to focus on dividends and share buybacks, there is fear that they are chasing production growth, which could lead to market imbalance similar to previous periods of overproduction.” However, corporate guidance has confirmed much more modest growth rates going forward, suggesting 2023 was an anomaly.

Long-term oil demand is driven by population growth and rising living standards in non-OECD countries, creating a strong relationship between economic growth and energy consumption. Nuttall points out that the energy transition away from traditional fuels will take much longer than policymakers suggest, making natural gas a significant beneficiary. “The real drivers going forward are population growth in non-OECD countries combined with rising living standards,” says Nuttall. The global disparity in energy accessibility and affordability

Energy accessibility and affordability

Energy companies have become top dividend payers and growers due to efforts to moderate growth, maximize free cash flow, and buy back shares. This strategy has been successful, leading to companies competing to return the most free cash flow to shareholders, thereby driving higher stock prices. Nuttall explains, “The path toward getting higher share prices is not one of production growth but one of moderating growth, maximizing free cash flow, and using that to meaningfully buy back your shares.” Nuttall asserts, “I believe we’re in a multi-year bull market not just for oil but for natural gas, for coal, just energy in general.”

Energy companies as dividend payers

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