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Woah-Oh We’re Halfway There…

Has it been 6 months already? How time flies when your forecast is getting munched up and spat out like so much doggie kibble. I feel, rightly or wrongly, that this year has been particularly unpredictable, even if we do have the world’s most predictable politician sitting in the White House instead of that other dude.

 

Maybe it has something to do with Coronavirus recovery, maybe it has to do with the energy transition, I’m not 100% certain but the general sense I have is one of flux and volatility.

 

Or maybe I’m just mad that I completely hedged my bets on the price of oil and I am left holding on to a low ball prediction while the rest of the world charges out of the gates to a $100 handle.

 

Who really knows. But you know what “they” say, out of volatility comes opportunity (or chaos, but that’s just splitting hairs) and as I look at our business and try and crystal ball the next twelve months, I see an exceptionally busy time, filled with significant potential for all parts of the Western Canadian economy, but most importantly, for the energy sector writ large, which is a good thing because as they say, you can take the energy out of the brand, but you can’t take the brand out of energy. Actually no one says that, but you know what I mean.

 

At any rate, back to the matter at hand.

 

The dreaded six month review. This is where the short term easy wins start to morph into secular trends that it is extremely likely I have completely whiffed on.

 

For example, sports. For the Stanley Cup I picked “not Toronto” which was actually the easiest pick ever, but could anyone have predicted the Habs to make it this far?

 

Interestingly, I made no predictions about vaccine rollouts and left that to the rocket geniuses in the punditry and political classes. Surprisingly they were all wrong.

 

If I had predicted back at the beginning of January that Canada would be a world leader in vaccine rollout by mid July and that Alberta would be reopening on July 1 (Best Summer EverTM), I probably would have been handcuffed and taken to the looney bin. Yet here we are. Never underestimate the capacity of Canadians to “get ‘er done” when faced with the prospect of losing even a week of summer vacation time.

 

All of that lead-in as part of my haf year avoidance program, but there is no hiding anymore.

 

Time to face the music, pay the piper, grin and bear it, face the facts, bite the bullet, take my lumps and swallow my medicine.

 

And without further evasive ado, I present to you, Q2. Rhyme intended.

 

 

Broad Themes

 

Politics and Stuff

 

Last year, civil unrest and the US Presidential election was my pick to be front and centre on the North American and global front for the course of the year.

 

This year I figured it wouldn’t be much different and posited that without his presence on social media (banned from Parler, Twitter, Facebook, YouTube, Tiktok, SnapChat, Instagram, Shopify, MySpace) that the influence of Trump that  Trumpism, such as it is, would eventually die out,

 

As the first five and a half months of the Biden presidency have unfolded, it has in fact been quite refreshing to have Trump decidedly in the background and fading with none of his range of sycophants and family possessing even a fraction of his charisma or ability to command the limelight.

 

Jack Dorsey’s single most impactful contribution to civil society may not in fact be Twitter, but rather the decision to cut Trump off from it.

 

That said, there has been a gradual reinflation of Trump noise, from his decidedly awful blog (from the desk of Donald J Trump) to a few rallies and photo ops, but by far the biggest publicity Trump has garnered so far has been from the recent indictment of his CFO and the Trump Organization on charges that can only be characterized as tax evasion.

 

I don’t want to get into the specifics of anything, because in many ways I don’t really care, and many pundits are saying all this stuff is small potatoes (and they may be right), but the gist of it for me is the eighth count where the whole shitteroo is being charged with falsifying financial statements (they apparently maintained two sets of books like the amateur-hour crime family they are). For a finance guy like me this means that all of the Trump lenders are now free to declare loans in default of reporting covenants, allowing them to call their loans if they so choose. I wouldn’t want to be the banker who waits too long on that one. Watch that closely as this trial unfolds.

 

Another comment I made was with respect to the fracturing of the Republican party. Unlike others, I don’t view it as permanent and I see it being put back together but at this stage, no leader has yet emerged with the chops to pull off any rebuilding effort. Time will tell and a third party could yet emerge, but so far, Q whackos aside, the party is holding together. Meanwhile, individual Republican led states are taking their revenge on an electorate that dared to support the Democrats and are systematically dismantling the electoral

 

I predicted that the lesson of course will be lost on Canada’s conservatives who are also fracturing, even if they don’t know it. Weak leadership and pandering to the fringes is a recipe for disaster that Canadian conservatives are all too familiar with such as the PC/Reform/Bloc/CCRAP/CPC evolution and our very own PC/Wildrose/UCP and resultant Humpty Dumptying.

 

Tell me I’m wrong so far in 2021!

 

Against this backdrop is my biggest US forecast, namely that Biden will be, in my estimation, the single most boring US administration in memory.

 

Joe Biden’s mandate is clear. Manage through the rest of the pandemic, restore the economy, which is in much worse shape than anyone wants to talk about, rebuild the US brand internationally and create a sense of unity and common purpose around all the preceding. It is a tall task for a president who probably should be taking afternoon naps at this stage of his life, but it’s his moment and it sure hasn’t seemed too big for him yet. Stimulus, infrastructure, vaccines. So far he’s winning.

 

Sure, there will be continued protest and conflict. It’s a big diverse country with many opposing viewpoints. But starved of oxygen, I don’t how Trumpism survives. Reality is I don’t believe that deep down anyone actually wants it to anyway – even the most ardent supporters. It’s just too damn exhausting.

 

Here in Canada, I boldly predicted that we are about to have (another) Federal election. My reasoning? Because the Liberals are sharks while the opposition is basically a couple of muppets with paper cuts flailing in the water. My reasoning was that if the tide turns against the pandemic with vaccines and cash, then that is the time to engineer an election as opposed to when the bills come in.

 

My forecast was and still is a Federal election sooner than later, a Trudeau/Liberal majority and Trudeau quits by year end and PM Freeland takes charge. I stand by it.

 

Plus Trudeau recently got a haircut and shaved his beard – he’s the drama teacher, costumed messenger – this means back to business.

 

I predicted 2021 should see a return to and continuation of some regional tensions.

 

The Iran crisis, which has been ongoing for more than 40 years will continue to percolate. A robust nuclear program is their goal and they will challenge Biden early. So far, Iran has not disappointed and Biden is actually more of a badass than they bargained for. The nuclear deal renegotiation is back on hold and the US is conducting airstrikes on Iranian backed militias. Merp.

 

China is the elephant in the room. Donald Trump’s unilateral and confusing approach to China did absolutely nothing to rein in this emerging superpower but the steps taken so far by Biden appear to have restored a quiet détente with the new yin to America’s yang. Hong Kong is lost so attention needs to be placed on Taiwan, Africa and South America to stem Chinese influence.

 

Russia is a big deal to the United States and Europe and a lesser deal to other countries around the world. I predicted that despite aspirations, Mother Russia will soon find itself increasingly hemmed in by a vengeful US government intent on exacting its pound of flesh for election interference and systems hacking, not to mention questionable loan guarantees to failed real estate developers. The prediction was that it may not be in 2021, but Putin is on his way out. You can only assassinate so many people.

 

Venezuela, which is in its 1219th year of economic stagnation seems destined to fall off the collective radar of powers that should want a peaceful resolution. This could create a vacuum that leads to conflict.

 

Another area to watch for conflict and humanitarian crises is Africa, whose countries comprise at least half of the top 10 humanitarian crises list for yet another year. Whether it’s starvation in the Democratic Republic of Congo, sectarian violence in Ethopia, Nigeria, Burkina Faso and South Sudan, 2021 promises to be a volatile year for the whole continent.

 

Grade: Halfway through 2021, I will give myself a B.

 

Energy and Environment

 

On the energy and environment front, I predicted that 2021 was going to be a year of transition.

 

How’s that for risk taking?

 

 

My theme for the year was going to be ESG and renewable energy as the Biden administration rejoins the Paris Accord, rolls out its massively ambitions green infrastructure agenda and the world continues to ambitiously pursue a net zero by 2050 agenda.

 

So far so good!

 

I didn’t really predict a heat dome, but here it is.

 

 

Against that I also highlighted the role for oil and gas in the energy transition and pointed out that pandemic ravaged capital programs are leading to pockets of energy shortages. Like all just in time worlds, while globally we may be currently oversupplied, local crises (like a frickin’ boat stuck in a canal or a heat dome) can have lasting impacts.

 

Stop spending here, create a shortage there and cause a mini-boom in yet another place. I predicted quiet in the Permian (a slow recovery) but a big comeback for Canada’s oilsands in 2021 and 2022 – at least for shareholders. While the rally in oil related shares has paused for now, Canada’s Free Cash vomiting producers are all the rage and you ignore them at your peril,

 

Finally, continued retirement of coal and nuclear generation facilities in the United States (2021 is going to be a BIG year for this) and abroad cannot be serviced by renewables alone which means that gas-fired generation will have to play a role. Or the lights go out. Like I actually said that. Are you paying attention to my predictive skills yet Texas? California? Germany? Anyone?

 

So, a renewed focus on energy transition, ESG and a bull market for natural gas and Canadian Oil Sands.

 

Grade: Incomplete, but pretty much bang on so far. B.

 

Price of oil

 

Every year this is the flagship call. It is the Toronto Maple Leafs of forecasting. Always looks good to start and then completely craters as the year unfolds.

 

First off, I predicted oil and gas demand was expected to increase by about 2%-3%, as the pandemic recovery continues. US production is down from prior years and OPEC +++++ has cut significantly with Saudi Arabia taking the lion’s share of the pain, in order to support prices.

 

Inventories are rapidly declining and depending on the pace of global recovery from the pandemic, by mid year I figured we could be dipping into spare OPEC capacity and lo and behold I was correct. Supply issues and alack of investment are creating a bit of a perfect storm for prices that will take some time resolve, even if Iran were to officially report its exports to China At the recent OPEC meeting (yesterday) it was agreed to continue gradually increasing output, so my timing looks pretty good.

 

With all this, alternative suppliers will be unable to ramp up supply fast enough – Iran will likely still be under sanction, Venezuela is a gasoline importing basket case and producers in the Permian are currently acting like the alligator armed cheapskate at the pub when the bill comes.

 

This leaves Canada as a place that can actually provide a steady, low decline and predictable supply.

 

My year end WTI price is $65.23 and my average price for the year was $57.38. At the end of Q2 these numbers were $73.47 and $62.05 respectively

 

Grade: Doing surprisingly well so far, but suspect I have undershot! B

 

Price of Natural Gas

 

Ah natural gas, I can’t quit you!

 

For the 5th year in a row, everyone’s favourite transition fossil fuel, natural gas, has been disappointing me and pretty much all of Canada with lousy pricing for what seems like forever. Showing great potential at times before collapsing back to “super-cheap alternate fuel – why don’t we use even more of it” status. And like any true forecaster for natural gas, we watch the storage reports with bated breath and hope for a polar vortex or a heat dome to descend somewhere, anywhere really in order to spike prices and prove our bullish forecasts right for yet another fleeting week before crashing back to earth.

 

Here’s the thesis. Gas consumption in the US is way up. Exports of LNG are growing rapidly and exports to Mexico are also rising. Thanks to a variety of price and COVID induced factors, supply in the United States has stalled out, even with the reliable Canadian relief valve. The catalyst for gas that was a still a year or two out is now right in front of us – LNG Canada, more export capacity out of the US, the completion of the coal to gas power conversion.

 

It’s a multi-year play, but I predicted that 2022 was going to be better than 2021 but 2021 was going to be better than 2020 which was an OK gas year

 

My year end price for natural gas (NYMEX) was $3.93 and the average price $3.07. AECO will again have a better year than I think many Canadian producers are used to, which, combined with oil sands prospects should be a welcome bonus for the Alberta government’s coffers. At the end of Q1, gas was a disappointing $3.66 and $2.84.

 

Grade: Actually pretty good but way too much time left for prices to collapse and crush my spirit. B-

 

 

Production

 

 

I predicted that for many producers in the Permian and continental United States, 2021 was going to be a weird year. While drilling will recover with prices over the course of the year, it isn’t going to be dramatic as players wait to see what the Biden administration rolls out.  More impactful however will be the fallout from 2020’s collapse in the rig count and the number of wells drilled and completed. To maintain production against its epic decline rates, the US LTO industry needs to drill and complete thousands of wells every year. This volume was not met in 2020 and the production impact is going to reverberate throughout 2021 regardless of any drilling activity over the course of the year.

 

 

Capital for new drilling programs is scarce, the pace of completions has slowed to decade lows and the rig count was down 600 from the beginning of 2020. The monstrous DUC inventory has been mined and the dirty little secret of the DUC count is that probably a quarter of these were never going to completed anyway. Rig count is growing modestly as companies live within their means and target maintenance of production levels with modest growth as commodity prices allow. While in 2019 and 2020 a significant amount of capital found its way into the Gulf of Mexico, the Biden approach to offshore may slow that plan down.

 

 

All of the preceding is my long-winded way of saying that I believed that US production would decline early in the year before recovering into year end. Year end production in the US was 11 million boepd and I picked the exact same level for year end.

 

Current production in the US is 11.1 million bpd.

 

Grade: Incomplete. C

 

In Canada, activity levels should over the course of the year more closely resemble 2019 than 2020. Pockets of conventional unconventional (tight oil, deep basin, condensate, liquids rich) activity in places like the Duvernay/Montney/Viking and the Bakken but not much in between. Rig count will also pick up in British Columbia as drilling to support LNG Canada picks up. Continued optimization and slow-footed brownfield expansion in the oilsands will continue, but not much more.

 

While the year will be bullish for oilsands producers and investors, the market signals are not all in for any material expansion. We are thinking not much growth above replacement of natural declines, notwithstanding recent record production levels. If Enbridge can get Line 3 substantially advanced (recent announcement by Biden administration says it’s got support to complete), expect some whispers of announcements of expansion.

 

OPEC production levels will depend on what happens with the re-upped OPEC/NOPEC agreement at the various jump-off points through the year. The key to the agreement is the Saudi/Russia collaboration and unilateral Saudi cuts which were planned to continue until June. We expected that OPEC/NOPEC output should be flat year over year, with the extra Saudi cuts (implemented in 2021) unwinding as the market strengthens

 

In the rest of the world, we projected a limited growth scenario. New projects in the North Sea (Johan Sverdrup field) will continue to ramp up and investments in Africa will come on-line. Latin America will be sold as a growth area – look for Brazil to disappoint because that is what they do – but material growth is a couple of years out.

 

The fact that global supply growth is not expected to come from a slowing US shale sector should be concerning because it now starkly exposes the lack of investment in other regions and being such a capital dependent industry, production can turn negative as quickly as it ramps up. Inventories can come down very rapidly and we have seen over the last few years how difficult it is to reverse a trend once it starts. If the global economy recovers quickly from the pandemic induced consumption decline, it would not be surprising to see consumption snapping back above 100 million barrels of oil a day by year end which would constitute a supply crisis and the resultant price spike could stick a pin in the economic recovery. We actually need production growth.

 

Grade: It is still too early to tell, but OPEC opening up more production as actually a bullish signal. B

 

Activity Levels

 

On the Canadian side, notwithstanding my relatively bullish sentiment, this year is going to be a hard one to predict. 2020 was the worst year on record for Canadian E&P, so a repeat is unlikely.

That said, there is always a lot of uncertainty in the Canadian market given our well-documented egress issues, pricing dilemmas and purported federal government hostility to industry. While we no longer are subject to free natural gas for extended periods of time (props for AECO) and differentials have settled down, these price signals are taking their sweet time converting into upstream activity.

As I have explained previously, given Canada’s production mix, the need to drill isn’t consistent across the basin. With only about 25% of Canadian production subject to high decline rates, the incentive to drill isn’t always there because the pipes are full of heavy oil. Plus, we don’t have the intense drilling imperative that the US has, where more than half of their production has a 35% decline rate and lower production levels per well, so they have to drill like lunatics just to stay in one place.

Canadians are creatures of habit and in winter we drill, but breakup came early this year.

I predicted that activity in Western Canada would be … pretty much flat with 2019. This ironically will represent a spectacular recovery to what was an awful year. Capex in the first half of 2021 was expected to be restrained but activity was predicted to pick up in the latter stages of the year on the impending completion of Line 3. So less activity in H1 is going to trade off high relative activity in H2.

My bold prediction was 4,000 – 4,250 combined oil and gas completions in 2021. Capex should be up 15%, with an upside for 20%.

Rig count in Canada at this stage of the year is actually ahead of 2019. So far, so good. Fingers and toes crossed.

It’s already been discussed elsewhere but I predicted that in the US, drilling activity will be flat and capex is will be up 5%. True to form, a lot of rigs have been added in the first half of the year, but nowhere near the levels the last time prices were this robust.

Grade: Incomplete as it’s a year end thing, but the start is OK. C

M&A Activity

 

I predicted that a late 2020 robust M&A trend would continue through 2021 as property consolidation, non-core asset sales and private equity investment all pick up as the industry adjusts, yet again, to a new normal. M&A activity was predicted to be broadly based – upstream, downstream, oil, gas, services and everything in between.

 

On the Canadian side, M&A activity should pick up as portfolio rotation out of the Permian brings American and international investors back to Canada and our absurdly high Free Cash Flow yields start to attract interest.

 

Capital was predicted to become easier to access as the year progresses and the prospects for the industry firm up.

 

As always Canadian companies that are historically undervalued cash cows will attract interest as investors tire of Elon Musk, Tesla and scammy ShitCoins.

 

I predicted a prominent Canadian name or two would find themselves with new foreign owners as the year progresses. This may play out in the gas space as opposed to oily names with construction on LNG Canada progressing.

 

On the services side, we are very bullish on energy infrastructure and related industries and see that as an area where Canada will see a fair amount of activity.  Mid and downstream oriented companies will continue to be of interest to strategic consolidators and private equity. Right on cue, multiple bids have emerged for Inter-Provincial Pipelines. We figured upstream M&A would pick up in H2.

 

So far we have seen some pretty robust activity in Canada. Our more than $20 billion in deals so far represent 16% of global transaction value. Highlights include:

 

  • Secure Energy Services buying Tervita
  • Arc Resources and Seven Generations
  • Crescent Point and Shell Duvernay assets
  • Ensign Energy Services and Nabors Drilling
  • Waterous and Ossum
  • Tourmaline and Black Swan
  • Surge Energy and Astra Oil
  • Whitecap and Kicking Horse

 

 

Canadian Dollar

 

The prediction was for the Canadian dollar to reach perhaps as high as $0.80, maybe even $0.82. Current price $0.81

 

Grade: Duh. A

 

Infrastructure

 

Finally, right? I know in the media things look bleak, what with Trudeau and Biden, ESG and the energy transition and all that jazz, but we are of the view that we are kind if in the early to mid stages of an infrastructure supercycle in Canada which will continue well into the mid-2020s. Here’s my prediction:

 

  • Line 3 complete and operational by year end – so far so good.
  • TransMountain Expansion well underway with multiple spreads operating during the year in Alberta and BC. Yup
  • Coastal Gas Link continuing notwithstanding current challenges. Yup
  • Keystone XL, a Biden victim. He will give Trudeau a win on a different file, which may or may not help Alberta but is most likely to be Line 5.

 

More infrastructure positivity:

 

Some 70% of the planned spend on commercial wind and solar projects in Canada for the balance of the decade are planned for nasty carbon spewing Alberta. Nothing has changed that. Take that Laurentian elites! Combine that with continuing Petchem investment, Site C in BC, the NGTL expansion and other initiatives such as Carbon Sequestration and Storage and the conclusion is inescapable. People are spending money. In Western Canada. On something other than Vancouver real estate. Imagine if we got a battery play. People’s heads would explode.

 

Grade: For some reason I’m batting 1000 on infrastructure. Maybe not on heads exploding. A

 

Stock Picks

 

True to my rules, I picked two Canadian E&P’s as well as two service-oriented companies and, finally, one non-Canadian producer and a service company. If you recall my rules for oil and gas investing, one of them was to Trust Murray and I am thematically consistent with at least a third of my picks.

 

Pick #1 is Canadian Natural Resources. One day we will all be working for Murray Edwards, but for now, Murray’s company works for my Forecast.

 

Pick #2 is Cenovus. So yeah, I’m going hard on oilsands. Deal with it. Cenovus has been dumped on for years and recently swallowed Calgary icon Husky.

 

Pick #3 is Ensign Energy Services. Ensign is one of the largest land-based drilling companies in the world and also materially owned by, you guessed it, Murray Edwards.

 

Pick #4 is my renewable play Innergex Renewable Energy. Why them? Why not.

 

Pick #5 is Phillips 66. What? That’s right. A big refiner.

 

Pick #6 is a tanker business, tankfully not Suez focused. Scorpio Tankers Inc. based in Monaco, where Murray Edwards parks his boat.

 

Here’s how they are doing:

 

 

Stock Dec-20 31-Mar-21 30-Jun-20 % Change
CNRL 31.21 39.62 45.00 44.2%
Cenovus 7.91 9.86 11.86 49.9%
Ensign 0.93 1.18 2.24 140.9%
Innergex 28.00 22.73 21.55 -23.0%
Phillips 66* 69.88 83.16 85.82 22.8%
Scorpio Tankers* 11.50 18.63 22.05 91.7%
Average       54.4%
TSX Capped Energy 90.92 120.36 140.05 54.0%
*Not currency adjusted

 

 

That’s it! Outperformance held back because of… my renewable pick.

 

Grade: Incomplete. C

 

 

My time here is done. It’s a long weekend.

 

Happy Independence Day to all my South of 49 friends and readers.

 

Invest wisely.

 

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