On the Money with Dynamic Funds

PARTICIPANTS

Tom Dicker
Vice President and Portfolio Manager

Jennifer Stevenson
Vice President and Portfolio Manager

Mark Brisley: You're listening to On the Money with Dynamic Funds, from market insights and analysis to personal finance, investing, and beyond. On the Money covers it all, because when it comes to your money, we're on it.

Tom Dicker: We're here for another edition of On the Money. I'm your host, Tom Dicker, Vice President and Portfolio Manager at Dynamic Funds. I'm here with Jennifer Stevenson, the Lead Manager of Dynamic Energy Income Fund and Dynamic Strategic Energy Fund. Jennifer also co-manages several other funds, including Dynamic Energy Evolution Fund and the Dynamic Strategic Resource Fund, as well as the energy investments across the Equity Income team.

Jennifer is one of Canada's energy investing experts, with several decades of experience working directly in the oil and gas sector, later as an investment banker, and then for the last two decades as a buy-side portfolio manager. Jennifer has been with Dynamic on the Equity Income team since 2010 and has expanded our energy franchise meaningfully since then. One thing is for sure, because she covers energy, Jennifer has seen a lot of cycles.

Today, we're going to dive into the major topics in the energy sector, the current state of the energy market, the energy transition, long-term supply and demand drivers, and much more. Jennifer, I wanted to start out with a background question. You and I share a couple things in common in our early career, although we ended up in the same place. Two early events went the opposite direction. You applied for a job at McDonald's and didn't get that call returned, and then a job at a bank and that call did get returned. For me, it went the opposite way. Was that your first foray into the business world?

Jennifer Stevenson: Yes, it really was. My parents are academics and they're scientists, so business was not something that was discussed at the dinner table. It was more about biochemistry.

Tom: Did you go to school to take business?

Jennifer: No, I was going to be a vet because I grew up in a science household and science was amazing. I went to University of Calgary for undergrad and did all my science courses for the first couple of years. An option I took in my second year was a full year economics course, right at the same time that there was a massive blow-up in the market. You have an 8:00 AM Monday, Wednesday, Friday economics course and you get intrigued. I used all my science classes as my options transferred into the business program, which fortunately University of Calgary doesn't start until the third year. That was my foray into business. What I learned working for a bank and then what was exciting about an economics course in a really volatile market.

Tom: Certainly the market in Calgary depends really heavily on oil and gas. Did you find yourself exposed to oil and gas investment, and a lot of discussion about that when you were at the University of Calgary?

Jennifer: I didn't. There was a program you could take at U of C, which was part of the business program that was focused on petroleum land management. Because I didn't have any familiarity with oil and gas at that time, I didn't do that. I did finance. My first job out of undergrad in Calgary was unsurprisingly for an oil and gas company. That's where I got interested in the details of the business. I actually later went back and did some certification in petroleum land contract administration because that side of it was interesting.

Tom: You started your business career working directly for an energy company as an analyst, I believe. What got you into investment banking?

Jennifer: I started out, I worked for Petro-Canada actually as a summer student and then part-time through university, not at the gas station, at the big shiny tower downtown. Then when I graduated, I got a job with Amoco Canada. Petro-Canada was later bought by Suncor, Amoco Canada was later bought by BP. I worked in that business for four or five years. Then I had always wanted to go back and do more school. I thought, well, I like the business side, like the oil and gas business. I went up to the University of Alberta and went in there, combined MBA law program and furthered my education that way with an idea to come back into the business community in the oil and gas sector when I was finished.

Tom: What did you like about the oil and gas business?

Jennifer: The people in it are amazing, like a lot of great ideas, a lot of energy. The environment is really dynamic because the price is changing and you're discovering things with the wells you drill. You're thinking about product transportation pipelines and marketing that product and the price of that product. Every aspect of it is always in flux and always changing and that there needs to be a long-term plan that can then react as things change. It's just pretty exciting place to be.

Tom: Do you think the oil and gas industry attracts a specific type of personality?

Jennifer: Yes, I do. I think the type of personality it attracts has changed over time. The fundamental people that I think are successful in and attracted to the oil and gas business are people that can react to things that change and yet understand the value that they're creating by producing this product that allows the economic development that we have to continue.

Tom: You did your MBA. How did you get into the investment banking business?

Jennifer: I did the MBA part of my combined degree. I never actually did the law part. You have to pick a year to do first at the program. I was lucky enough to get a scholarship to do the MBA year first, so I did that. Then when I was going to go back to Amoco for my summer job in between my first and second year of grad school, that was another big downturn. You talk about seeing cycles, ta-da. Amoco canceled their summer student program.

My younger sister was an engineer who worked for a company called Canadian Hunter, and one of the guys that she worked for was just starting with another group of individuals, an energy mergers and acquisition boutique called Wilson Mackie & Company. Brett Wilson and Jamie Mackie, I went to work for them for a summer. I had my finance background; I had my oil and gas background. Then I was working with these gentlemen that were doing oil and gas property acquisitions investors.That got me really interested in that part of investment banking. While I was there, Wilson Mackie became a bigger entity, and other people joined from different parts of the business and created a company called FirstEnergy Capital. I became like the second corporate finance employee at FirstEnergy Capital and I went away for a semester and finished the rest of my MBA, didn't do any law, and went into investment banking.

That got me really interested in that part of investment banking. While I was there, Wilson Mackie became a bigger entity, and other people joined from different parts of the business and created a company called FirstEnergy Capital. I became like the second corporate finance employee at FirstEnergy Capital and I went away for a semester and finished the rest of my MBA, didn't do any law, and went into investment banking.

Tom: In my previous life, I certainly dealt with FirstEnergy quite frequently and they were definitely a leading investment boutique. What made you want to transition to the buy side?

Jennifer: FirstEnergy was great, and I worked there for six or seven years. Then I decided I'd like a broader experience. Still in Calgary, still focused on oil and gas investment banking, but with a more national presence. I went to work with Midland Walwyn, and then we were bought by Merrill Lynch. That was a really exciting time. Through that, I started to feel like I was losing that direct exposure to the assets and the people and what makes the business tick. I left investment banking, I just quit and thought about how I was going to get back into that exposure.

Would I go work for a gas company or do something else? I thought about what I really liked about the oil and gas business was the different projects, the different people, and seeing those projects to fruition and what the companies were doing. I thought, I can do the same sort of thing that we did on investment banking, but I can be the other side. Be the person making the investment decisions. I went to work for a company that was doing that.

Tom: How did you end up here?

Jennifer: I worked for a small buy-side shop for about four or five years. I was starting to think personally in my head that something broader would be more exciting, some different types of investments within energy. I was on BNN regularly and Oscar Bleiche, who was looking for an oil and gas person, saw me and said, "Hey, we should talk to her." That's how it happened.

Tom: You've been here since 2011. You've seen a lot of cycles. Certainly, the most recent big cycle was something I thought I would never see. If we go back in time to the depths of COVID, the oil price went negative and it's up a lot since then. It's up in a lot of the face of what's supposed to be a green revolution with electric vehicles. What happened?

Jennifer: The negative oil price thing, it was real, but they didn't go negative everywhere in the world. They went negative for WTI, which is West Texas Intermediate, which is the oil price that's priced in Cushing, Oklahoma, and that's the price you see in the paper. That's what everybody quotes. The other big international oil price is called Brent, and it's price referenced in the North Sea. Brent didn't go negative. The reason WTI went negative and Brent didn't is that if you own a futures contract, which is just a financial contract, and you hold it until it closes, you have to take delivery, physical delivery of those oil barrels, if it's a WTI contract.

If it's a Brent contract, you can sell that contract at the last minute. You can do financial settlement. You don't have to do physical. People that speculate on oil, which a lot of people like to do, the financial market for oil is much larger than the physical market. In the physical market today, we burn up 100 million barrels a day of oil. The financial market is multiples of that. When oil prices went negative at WTI, you had a bunch of people who were long those contracts, they did not have the ability to take physical delivery. Basically, they were paying somebody who did have the ability to take physical delivery to take it off their hands. To do that means the contract price went negative for a day, but super headline craziness.

Tom: In the face of the Inflation Reduction Act, in the face of tons of investment in renewable energy, what's going on the supply and demand side that's caused this move up from negative oil prices to $100 oil over the last few years?

Jennifer: I think initially when the green transition first became popular in the media, there was an expectation that the transition would be like walking into a room and flipping a light switch. It's just not physically possible to have it happen that quickly. The scare from the COVID demand shock, which was legitimate because the world shut down, we've never seen a demand reduction like that. Oil and gas companies were very conservative with their capital spending, so they weren't drilling wells. We didn't have that backlog of wells to bring on production when the COVID recovery happened, and the world opened back up and demand for oil and gas went back up.

We used up oil and gas that we had stored, and those wells were slow to get back on a drilling schedule. The inventories were low. The price went up to try and encourage supply demand. It works in real life, right? The price of oil went up to encourage companies to spend more capital, to drill more wells, to meet that demand. What we didn't have was the renewable sources of energy are, they're growing too. The system is not set up that it can replace instantly what we've been using for 100 years. It will take another 100 years to do something that dramatic. The oil price has gone up because the population continues to grow.

Economies recover from COVID quickly and then economic growth is still a few percent a year, driven by that population growth. On top of that, we've got things like concerns about energy security and energy availability. That puts more of a value on this baseload of energy supply like natural gas, oil, which is made into things like gasoline and diesel and heating oil. So that you've got that base demand, limited supply, companies are prudent with capital and this transition is long-term. We're in a much structurally stronger place for oil prices going forward.

Tom: It sounds like it's a classic case of any glut leading to a shortage. There was too much supply for a brief period of time during COVID, the taps all get turned off, drilling slows down, and now you've got a bit of a shortage in the market. Obviously, that's exacerbated by the war in Ukraine. Then obviously the demand coming back in China. What's happening with the energy sanctions that have been put on Russia? Has that actually impacted their oil's ability to get to market?

Jennifer: When Russia invaded Ukraine, there was immediate concern about all of their production not being available to the world and it's a global oil market. Pick a round number, Russia's about four and a half million barrels a day of oil supply. Sanctions went in place. You couldn't buy Russian oil. You couldn't buy Russian oil over a certain price. You couldn't ship Russian oil on certain tankers. You couldn't get insurance. Over time, the logistics of the sanctions versus oil demand versus available transport, et cetera, most of those barrels remained on the market.

They just get sold to different places. We didn't suffer a lot of price increase because of the lack of Russian barrels. We had some price increase because we had to substitute where it went, shipping costs more. It really focused the world on energy security because you realize that we don't have voluminous amounts of oil in storage. We're almost a just-in-time system. If you get a big supply disruption, it could be serious as far as price increases and economic consequences. That energy security focus remains top of mind.

Tom: Has that changed the way companies in North America invest?

Jennifer: I think that reinforced how they invest. The biggest thing that changed how companies in North America invest is when US shale oil was growing and then able to grow really quickly because the technology allowed them to drill multiple horizontal wells and long horizontal wells and have this huge production growth. The market was rewarding these companies. It was almost, in my opinion, a growth-at-any-cost type of environment. It was more about top-line growth. Management was compensated for top-line growth, not the economics of what they were producing.

What changed companies is we went through that phase. They weren't financially healthy, a lot of them. When we had that oil downturn with COVID, that was sort of the end of that era of capital-free type of spending. Now we're in a very much capital discipline, shareholder return type of environment. Even though oil prices have recovered dramatically since the lows of COVID and like we talked about when oil went negative, the capital discipline has stuck. That's the biggest focus. It's global and it's particularly with the US companies who were exposed in that big shale boom era several years ago.

Tom: Have you seen companies change the incentive structure for management teams so that they're compensated differently, more about free cash flow or shareholder returns and less about production growth?

Jennifer: Yes, very much so. Especially with the companies in the States, they were much more focused on that top-line growth. Now the executive compensation structure is much more on shareholder returns and asset value and things that we like as investors. That congruence is great.

Tom: With the oil price in the 70s and 80s, where it's been recently, what sort of returns can these companies earn?

Jennifer: The returns are really, really strong because when you look at the full cycle costs for these companies to produce say a barrel of oil, $50 is a good solid number. There's a number of companies that are in the 40s, but when you sort of use an industry average, $50 is a good number. If you're all-in costs are 50 and you can sell it for 75, you're making some really great free cash flow that you can then turn around and use to reinvest in your business and keep that free cash flow stream growing. Also, pay out to your shareholders and pay down your balance sheet so that the companies are really healthy.

Tom: What do the balance sheets look like right now? I know it's tough to generalize, but what are the debt to EBITDA ratios and what are the free cash flow yields like right now?

Jennifer: The capital discipline has allowed the companies, and there's always been a difference between Canada and the US. Canadians, we are more conservative, we carry less debt even in the oil and gas business, and the American companies always carried more debt. For the oil and gas producers, they are under one times debt to cash flow. In historical times, the Canadian guys might be one, one and a half, the US guys would be two plus, and that's at a commodity price that they were happy with.

Then as soon as those commodity prices tank, then the debt ratios go out of control. Now they're under one times debt to cash flow. They’ve got lots of flexibility there. Free cash flow yields anywhere, say 11 to 15%. When you're 11, 15% free cash flow yield and you got a dividend yield of five or six, that helps you keep your balance sheet down. That allows you to do buybacks. If you think there's good value in your stock, they've just got a lot of flexibility.

Tom: You said the Canadian companies are generally more conservative. I've noticed definitely there have been periods where the Canadian E&P's will really underperform the US and sometimes the opposite is true. Is Canada well positioned right now from an oil and gas production standpoint?

Jennifer: Yes, that's a good insight because when the US shale companies were really sexy, Canada was overlooked. Then the US came back to earth. One of the things that came out of the shale era in the States was a focus on company inventory. How much resource and booked reserves do you have on the book? Then we can make an assessment of the longevity of your cash flow stream. The oil sands in Canada are the longest reserve life anywhere, 50 years plus. That's attractive. The Montney play in Alberta and BC is a shale play and it's huge and very attractive.

What Canada has going for it is we've got the resource, we've got the duration, we've got a regulatory environment that's clear. We've got rule of law. We've got policies in place that everybody knows what they are. The biggest hold-up before now has been, oh, but they can't get their oil or gas out of the country as much as they want. That's now not an issue because the TMX pipeline, which is the Trans-Mountain expansion, which goes essentially from Edmonton to Vancouver, is about to come on in about a few weeks. We've also got the Coastal GasLink pipeline, which goes into BC and out to the coast for the Shell-led LNG Canada Project.

We've also had expansions to Enbridge Mainline. We've had expansions of gas pipelines going south. Western Canada is in a situation now that for the first time ever, we will have excess oil and natural gas takeaway capacity, which means we will not have these widely varying discounts on our prices compared to, say, prices in the United States or globally, because we can get our product to those markets. That, with our ongoing capital discipline, with our deep resource base, with our steady structure, I think makes it a really attractive place for investment.

Tom: I don't know about you, but it sounds like the Canadian energy companies have this really long reserve life. When I'm looking at them, I don't see a massive discrepancy in terms of the price-to-earnings ratio, say of a Canadian energy company relative to the US companies. Do you think that this opportunity is really underappreciated by the global investment market?

Jennifer: I really do, and I don't want to sound like I'm biased rah-rah Canada, but we're global investors in oil and energy companies in Europe, in the United States, in Canada. When I look at those areas as an investor and think about where you get checks and where you get Xs, Canada has a lot of check marks right now. I am hearing that from US or European analysts that cover the broad sector. They're saying, yes, Canada's looking really good. What's twigged them is the energy security, that duration of inventory that you mentioned, and also our egress, meaning we can get our products out to a global market. Those are two big advantages that we've got going for us.

Tom: One of the other things that's taking place is that we have this perception that energy security is not that important as a lagging consideration that's obviously moving more towards Canada. Then you've got this lagging perception that we don't have any pipelines, that we're a very energy-unfriendly place politically to invest in. That's obviously no longer the case. In light of that, is the Canadian E&P landscape an attractive place for global companies to want to do some M&A? Could some of the Canadian companies be M&A targets?

Jennifer: Theoretically, they could. Big global companies are already active in Canada. ConocoPhillips is really active in Canada. Shell is really active in Canada. Other companies have sold out of Canada years ago. Might they come back? Perhaps. Our biggest companies in Canada that have the best assets are quite large, so there's a more limited audience as to who would buy them.

I think if you're looking at buying somebody really large, then you might get into concerns from government and that sort of thing about who owns those assets and who controls them. Within Canada, I still think there's more consolidation that can happen with some of our smaller or mid-sized companies getting together. Some of our larger companies adding some assets in the form of buying some mid-cap or smaller companies. I still think there'll be some M&A that goes on in the sector for sure.

Tom: Have you made investments on that basis in your funds?

Jennifer: I don't make investments on takeover spec. What happens is when you buy great assets in a company, if another company also thinks those assets are great and decides they want them, then they'll buy the company. That works out well for both of us. I just find buying something that looks cheap in the stock market because somebody might buy it is dumb because it's usually cheap for a reason. When we go in and do our due diligence, there's hair and we don't like it. We'll just stick with quality. Sometimes somebody else decides they like it more and they'll pay you extra and that's okay too.

Tom: Can we talk a little bit about OPEC? How much spare capacity do they have, and what direction is their spare capacity heading?

Jennifer: Yes. OPEC's interesting because you and I are talking, it is November 27th and OPEC was supposed to meet in person yesterday on the 26th. They're now meeting virtually on the 30th on Thursday. The reason that they delayed their meeting is because they're having some discussions apparently, and the people that we hear this from are legitimately plugged in with OPEC. The discussions they're having are about the quotas that were rehashed at their June meeting, and in particular the quotas from a couple of West African countries like Angola and Nigeria. I'm not concerned that there's not an OPEC agreement that comes out on Thursday.

What they're agreeing to is their quotas and also the level of production curtailment that they have underway. Right now, if you add Saudi's million barrels that they just did themselves at the June meeting plus what OPEC has curtailed, you add it all up and scrape all the bottoms of the buckets, you might get to about 5 million barrels a day of spare capacity. I'd say maybe three and a half or four of that is something that you could actually see produced long-term. The cohesion of OPEC is as much about a price that sustains their need for capital for economic growth, as much as it is about reducing price volatility.

That's a big focus, especially for Saudi Arabia, that is the de facto head of OPEC+. For price volatility reduction being a focus for them, it just makes it easier for their customers to plan, to understand. It's just a less stressed place for the whole market. When you think about the spare capacity, you want OPEC to have some spare capacity. Because then if there's a disruption, whether it's a war, somebody blows up a pipeline, we've seen that happen. Somebody sends some drones in and blows up a big processing facility. We've seen that happen. You've got to come back because otherwise, you'll have a massive price spike and that'll be impactful around the world.

That's one good reason to have some spare capacity in OPEC. The other reason, the way to think about spare capacity is it's kind of political. OPEC's not going to just put their spare capacity on and put the price down if everybody buying the oil is happy with the current price. Having spare capacity might allow them to curry some political favor, say if gasoline prices go up and it's the US election year, I'm just waxing poetic, but that kind of thing is important. White House relations with OPEC and the reverse can be true too. OPEC's got, round numbers, about 5 million barrels a day of "spare capacity."

Tom: Is it fair to say you use the word cohesion. As OPEC entered after a period of some extreme volatility around COVID, and them sounding like they weren't getting along with Russia. Have they come into a new era of a more cohesive, more call it, dare I say, predictable era?

Jennifer: I would say that that's true. We had a price war or a lesson taught, in my opinion, between Saudi Arabia and Russia through COVID. Because simplistically Russia decided they weren't going to comply with the cuts and they're a big part of that OPEC+, the plus is Russia, that OPEC+ volume maintenance, when Russia went AWOL, Saudi said, "Okay, no, this is a group thing. If you're going to mess with the group, we're going to hammer the price." Saudi put a bunch of production on the market, the price flattened out, and it honestly did not take long for Russia to come back and go, "Okay, we get it."

Let's all play nice in the sandbox with the goal being that price stability, a price that the people that buy the oil are happy with and a price that the people that sell the oil are happy with. I think having His Royal Highness Prince Abdulaziz as the Saudi representative of OPEC is key because I watch him. Every time there's an OPEC press conference, I'm on the TV, 3:00 in the morning, I don't care. Because he's that amazing as far as his ability to deal with all of the different personalities involved in the OPEC plus group, and also understand the games that can be played by the financial markets on the oil price.

He has lots of quoted little sayings. One of them that will be forever burned in my brain is he wants the shorts to be ouching like hell. Those were his words, which means you can see how the oil price is affected by the financial market for oil. We talked earlier about how much larger the financial market is for oil than the physical market. The financial market is just people buying futures contracts long or short. When he sees a big short position in oil futures, which is damaging the price of the physical barrel, he has gone in and OPEC has agreed to do things that catch those shorts off guard and make them cover. Then they become more wary of putting on that position and messing up the OPEC plan for reduced price volatility.

I do think we're in an era of OPEC understanding, OPEC cooperation, OPEC cohesion. Saudi in June, when they did the extra million barrel a day of cuts, just Saudi took those on. It was essentially to reward the rest of OPEC for agreeing to quota reassignment because there was a bunch of countries that had quota they weren't using. There was countries who had spent money developing their energy reserves or oil product and needed quota and they reshuffled it so it was more equitable. That was the bonus for them as a society made a million barrel a day cut, prices were strong, everybody was satisfied. I do think we've got that cohesion within OPEC going forward, which is good for oil markets. It's good for investors and producers within in my view.

Tom: For the folks that are listening, what are some other things that they could do if they wanted to follow the energy markets? What are some sources that you really like and find trusted?

Jennifer: There's a lot of gobbledygook out there and there's a few good things. The good things are harder to find because sometimes you have to pay for them. Helima Croft on CNBC, she's worth listening to, from Amrita Sen from Energy Aspects, she's worth listening to, Sankey, Martin Rätz, Jan Stewart, those are some of the people that they know the geopolitics, they count the barrels, they think logically and rationally and they're not prone to hype. When those code names, those are worth listening to.

Tom: Are there any books on energy or the energy transition that you'd recommend to people?

Jennifer: It's hard to write a book about something that's in process. What I've found is I've read a lot of books about climate and thought about how that impacts energy. The things I like are, they always seem to be written by physicists. I don't know what it is about the physicists that can drill through a lot of the hype and the noise. Mark Mills, I read what he writes in this area. Steve Koonin, I read what he writes in this area. I just like to have a really wide view because if you just watch the news or read the paper, I find a lot of times it's one-sided and it's quite alarmist as opposed to being more scientific and factually based.

Tom: How about Vaclav Smil's book, How the World Really Works?

Jennifer: How the World Really Works is a great book and it's across all sectors. It's got snippets of data from everything, and every time you turn a page, you go, no way. When you see the facts and you think about it, you go, makes sense. I like that. I like plain English sense.

Tom: Jennifer, thank you so much for this conversation. I learned a ton and thanks to all our listeners. Again, this is another edition of On the Money, and on behalf of all of us at Dynamic Funds, we wish you all continued good health and safety. Thanks for joining us.

Mark: You've been listening to another edition of On the Money with Dynamic Funds. For more information on Dynamic and our complete lineup of actively managed funds, contact your financial advisor or visit our website at dynamic.ca. Thanks for joining us.

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