Market Call: Eric Nuttall's outlook on Energy Stocks

Key Concepts

• Post-Shale World: The shift away from US shale as the primary driver of non-OPEC oil supply growth.
• Inventory Build/Draw: The change in oil and gas storage levels, impacting price expectations.
• Free Cash Flow (FCF): Cash generated by a company after accounting for capital expenditures; a key metric for shareholder returns.
• Hedging: Strategies used to mitigate price risk, often involving fixed-price contracts.
• Marginal Cost of Supply: The cost of producing the last unit of a commodity, often used as a price floor.
• LNG (Liquefied Natural Gas): Natural gas cooled to a liquid state for easier transportation.
• Water Flood: A secondary oil recovery technique involving injecting water into a reservoir to maintain pressure and displace oil.
• Share Buybacks: A company repurchasing its own shares, reducing outstanding shares and potentially increasing earnings per share.

Energy Market Outlook & Stock Analysis – Eric Nuttall (Market Call, BNN Bloomberg)

Introduction

This summary details the insights shared by Eric Nuttall, Partner and Senior Portfolio Manager at Ninepoint Partners, during his appearance on BNN Bloomberg’s Market Call. The discussion focused on the energy sector, specifically oil and natural gas, with detailed analysis of individual companies and investment strategies.

I. SyNovus Asset Sale & Canadian Oil Sands

Nuttall views SyNovus’s planned sale of Alberta assets as a positive development. He doesn’t recommend owning the stock, citing its focus on oil sands expertise and past acquisition of Deep Basin assets. Monetizing these assets to reduce debt and accelerate capital return to shareholders is seen as favorable. He suggests the reported $3 billion figure is likely low, potentially closer to $4 billion. Potential buyers include Tourmaline, Peyto, and Canadian Natural (CNQ), with CNQ and Tourmaline being the most likely acquirers.

II. Bullish Oil Thesis – The “Post-Shale World”

Despite a challenging 2023, Nuttall maintains a bullish outlook on oil for 2024. His core argument centers on the transition to a “post-shale world.” He highlights that US shale production accounted for 117% of total non-OPEC supply growth over the past 14 years. The EIA (US Energy Information Administration) has confirmed that US production will begin to decline. This loss of a significant supply source, coupled with a 15 million barrel per day increase in global oil demand, creates a structural imbalance.

He criticizes the industry’s shift from exploration and drilling to maximizing free cash flow and shareholder returns, leading to a “brain drain” of geological expertise. He believes this leaves the world reliant on a limited number of countries (Canada, Guyana, Brazil) for production growth, setting the stage for a supply-demand mismatch and higher oil prices. He anticipates oil prices will need to rise significantly (beyond $70/barrel) to incentivize large-scale offshore projects and renewed exploration.

III. Company Specific Analysis – Oil & Gas Producers

• Headwater Exploration: Described as a “phenomenally well-run company,” but currently not held by Ninepoint due to a premium valuation (8.4x this year’s cash flow vs. 6.1x for Tamarack Valley). Headwater’s success in the Clearwater play, utilizing water flooding, is acknowledged, generating substantial free cash flow. Their expansion into the Grand Rapids play is noted as a positive growth initiative.
• Tamarack Valley: A preferred alternative to Headwater, offering similar management quality and properties at a more attractive valuation.
• Athabasca Oil: A core holding, benefiting from the Venezuelan situation. Nuttall believes the market overreacted to Venezuela’s potential increased production, creating a buying opportunity. Athabasca’s long-term inventory (40 years) and potential for significant production growth are highlighted.
• Cenovus: A large-cap pick, trading at 6.4x cash flow. Nuttall believes it’s materially undervalued, having resolved downstream challenges.
• Enerplus: Previously recommended, but now viewed less favorably due to valuation concerns.
• Baytex Energy: A shorter-term tactical position, benefiting from a pivot to Canadian operations and a significant share buyback program. Ninepoint has since exited the position.
• Whitecap Resources: A top pick in the income fund, praised for its management, assets, and consistent performance. A 20-25% dividend increase is anticipated.
• Topaz Energy: A relatively new holding, offering a combination of royalty streams, infrastructure, and growth potential.
• Peyto Exploration: A strong performer, benefiting from an acquisition and a focus on the Clearwater play.
• Cardinal Energy: Positive developments with Redford projects, but not currently held due to a premium valuation and concerns about debt-funded dividends.

IV. Natural Gas Focus & US vs. Canadian Exposure

Nuttall strongly advocates for increased exposure to US natural gas, citing the structural increase in demand from LNG exports (growing from 20 to 30-32 BCF/day) and data centers. He believes US gas producers benefit from closer proximity to demand centers and better pricing compared to Canadian producers. He recommends the following US natural gas producers:

• Expand Energy: Largest natural gas producer in North America, trading at 4.8x cash flow with a 13% FCF yield.
• EQT Corporation: A member of the S&P 500, offering easier access for generalist investors.
• Antero Resources: A smaller market cap ($10 billion) with significant upside potential, trading at 5x cash flow.

He notes that Canadian natural gas is at a disadvantage due to limited egress capacity and discounted pricing.

V. Investment Strategy & Fund Holdings

Nuttall manages two funds: an energy income fund and a flagship energy fund. The income fund utilizes a covered call strategy to enhance yield, while the flagship fund focuses on capital appreciation. He emphasizes the importance of free cash flow, share buybacks, and long-term inventory in evaluating energy companies. He highlights the recent 14% distribution increase in the income fund, driven by the covered call strategy.

VI. Venezuela & Geopolitical Considerations

Nuttall dismisses concerns about increased oil supply from Venezuela, arguing that the infrastructure challenges and political risks make a significant, rapid increase unlikely. He believes the market overreacted to the potential for Venezuelan oil to disrupt the bullish oil thesis.

Conclusion

Eric Nuttall presents a compelling case for a bullish outlook on the energy sector, particularly oil and US natural gas. He emphasizes the structural shift towards a “post-shale world” and the importance of focusing on companies with strong free cash flow, long-term inventory, and strategic positioning. His recommendations prioritize US natural gas producers due to their proximity to growing demand and favorable pricing dynamics. He stresses the need for investors to prepare for higher oil prices and a potential mismatch between supply and demand.