Prefer U.S. natural gas producers: Nuttall

Key Concepts

• Oil Market Glut: Concerns about an oversupply of oil.
• Spare Capacity: The difference between OPEC's maximum production capacity and current production levels.
• LNG (Liquefied Natural Gas): Natural gas that has been cooled to a liquid state for easier transportation.
• Free Cash Flow Yield: A financial metric that represents the amount of free cash flow a company generates relative to its market capitalization.
• M&A (Mergers and Acquisitions): The process of companies combining or buying each other.
• Share Buybacks: When a company repurchases its own shares from the open market.
• Oil Sands Giants: Large companies involved in the extraction of oil from oil sands.

Oil Market Dynamics and Supply Concerns

Eric Notall expresses skepticism regarding the notion of a flooded oil market, dubbing it the "most anticipated oil supply or oil supply driven glut in history." Despite observable data like a surge of oil in the water, oil prices have remained stubbornly around $60 per barrel. Notall acknowledges the legitimacy of concerns about a buildup of oil in transit, much of which comprises sanctioned barrels now making their way to markets that could impact prices in the short term. However, he believes the market is aware of this and is beginning to focus on positive catalysts expected in 2026.

Demand Growth and OPEC's Role

Demand for oil is coming in hotter than initially expected. Forecasts from organizations like the IEA have been revised upwards, with some now predicting year-over-year growth of 1.2 to 1.4 million barrels per day, a significant increase from earlier estimates of 700,000 barrels per day.

US shale production is believed to be plateauing. While OPEC has increased production, this has primarily resulted in the normalization of spare capacity. Current demand is estimated at 105.5 to 106 million barrels per day, with OPEC's spare capacity only around 1.6 million barrels. Notall characterizes this as a "razor thin safety cushion," likening it to having "no fire insurance on a house in a neighborhood full of arsonists." This is particularly concerning given the ongoing geopolitical instability, such as Ukraine's attacks on Russian refineries (94% of which have been hit by at least one drone or missile), which presents a "very likely potential loss of supply."

Investment Strategy: Oil vs. Natural Gas

Notall expresses caution regarding oil investments in the short term due to uncertainty. He believes the market could easily swing to $55 per barrel or, if US sanctions on Russia are strictly enforced, to $65 per barrel, leaving him without a clear edge. The 9point Energy Fund, which he manages, has a relatively low weight of approximately 27% in oil.

In contrast, the fund is significantly more bullish on natural gas, holding about a 60% weight. Notall cites strong demand drivers and challenges to meaningfully growing supply in the short term as key reasons for this preference.

Natural Gas Investment Case

The stripped price for natural gas over the next three years (2026, 2027, and 2028) is projected to average around $4 per thousand cubic feet (mcf). At this price, Notall states that the largest gas producers in the United States are trading at compelling free cash flow yields of 12% to 14%.

Several factors support the bullish outlook for natural gas:

• LNG Expansion: The buildout of LNG export capacity in the United States is significant. Capacity is expected to grow from approximately 17 billion cubic feet per day (BCF/d) to 30 BCF/d by the end of the year.
• Power Demand Growth: States like Texas are experiencing increased power demand, up 5.5% year-over-year, driven by factors such as AI and data centers.

Even at the current $4/mcf price, which producers can lock in, Notall believes the free cash flow yields are very attractive. He suggests that the actual price could be "meaningfully higher than $4."

Canadian Natural Gas Dynamics

Notall also discusses the impact of LNG Canada's operations on Canadian natural gas. LNG Canada has begun producing LNG at its second train two months earlier than previously estimated. While there were initial "teething issues," this project is significant for Canadian natural gas.

Previously, Canadian gas producers were at the "end of the pipe," selling gas to the United States at a substantial discount. With LNG Canada coming online, adding approximately 2.1 BCF/d of feed gas (about 10% of Canadian gas supply), the discount is shrinking. Notall anticipates this discount will fall to around $1.10. By 2030-2031, Canada is expected to be shipping around 6 BCF/d of LNG out of the country.

However, Notall notes that Canadian producers lack the same "supply discipline" as their US counterparts, with larger producers continuing to add volumes to the market. This contrasts with US producers, who are more disciplined and willing to take supply off when prices soften. Consequently, the fund has a larger focus on US natural gas producers.

Mergers and Acquisitions (M&A) in the Energy Sector

Notall expresses concern about the ongoing trend of M&A in the energy sector, particularly the takeout of New Vista by Aventive. He describes this as his "greatest fear this year" due to depressed sentiment and valuations in the energy market, even though energy stocks have performed well.

The fund has lost three of its "favorite names" to acquisitions this year:

• Von: Previously a 12% weight, acquired by White Cap.
• Me: A long-term holding with an 8-10% weight, acquired by Senovas.
• New Vista: A 12% fund holding, being acquired by Ontivive.

Notall is not yet convinced about supporting the New Vista takeout deal and is considering voting against it, believing that shareholders might be selling too soon at a "fair valuation today" if they were patient and considered the long-term opportunity. He notes that his fund is the third-largest shareholder in New Vista.

Shareholder Sentiment and Long-Term Value

Gauging sentiment from various sources, Notall believes some New Vista shareholders are disappointed. He attributes this to a market where sentiment and valuations are challenged, despite stock performance. He hopes investors will "play the long game" and recognize the upside potential.

Notall uses the example of a hypothetical takeout of a company like MEG at $30. He argues that if one were more constructive on oil for the second half of 2026 and beyond, even at $70 oil, the fair value for that stock could be closer to $50. He questions whether investors should "trip over pennies on your way to dollars" by selling at a modest premium today when significantly more money could be made over time.

This potential for greater returns stems from:

• Higher Oil Prices: A more constructive oil price environment.
• Compounding Share Buybacks: Energy companies are actively repurchasing shares, which increases the value of remaining shares over time. This is seen as the "real upside in this sector."

Oil Sands Stocks Valuation

Notall holds a "modest weight" in one oil sands stock, but prefers not to name it, stating it's not Imperial, CNQ, or Suncor. He believes that the largest oil sands giants like CNQ and Suncor, while excellent companies, are "fairly valued" at $60 oil. He estimates CNQ at approximately 8.6 times cash flow and Suncor at 7.4 times cash flow, considering these valuations to be "fully valued."

For investors holding ETFs like the XEG, Notall points out they are "75% long oil" at a time when he sees greater upside in natural gas. He reiterates his strong bias towards natural gas, highlighting the opportunity to invest in companies trading at 12% to 14% free cash flow yields using strip prices. He notes that if weather conditions are favorable, a move from $4 to $5 natural gas could increase free cash flow yields from 13% to 20%. He believes fair value for the natural gas sector is at a 10% free cash flow yield, indicating significant upside potential.

Conclusion

Eric Notall's perspective suggests that while concerns about oil oversupply are present, the market may be overlooking positive demand catalysts and the tight spare capacity within OPEC. He is cautious on oil in the short term due to price volatility and uncertainty. Instead, he favors natural gas, citing strong demand drivers, limited supply growth, attractive valuations with high free cash flow yields, and the expanding LNG export market. The ongoing M&A activity in the energy sector is a concern, as it leads to the loss of promising companies at depressed valuations, potentially preventing investors from realizing long-term gains driven by compounding share buybacks. He views oil sands giants as fairly valued at current oil prices, further reinforcing his preference for natural gas.