Are We In An Energy Bull Market? With Fund Manager Eric Nuttall (Episode 4)

No, I think this year's a continuation of oil being in a multiyear bull market. It really started last year with the recovery of demand back to pre COVID, uh, levels despite still weak jet fuel demand. But I think the market's slowly realizing that the story is no longer about demand. It's all about supply. And I think there are structural supply challenges, both for us SHA growth for OPEC, for the global super majors that is essentially hurtling the world into a energy crisis, because, you know, if you were to ask the average person, energy ignorance, kind of clouds their view of the long term, or even short term role of oil in our, our lives. And that ignorance is leading to the lack of sufficient investment by the super majors, by the us codes, et cetera, to not invest in incremental new capacity. And so we've seen inventories fall to multi-year lows, and I expect that trend to continue.

Yeah, so, well, it comes down to the it's the demands of the owners. I, the shareholders of companies, and we need to recognize the energy space, you know, last year was, was obviously a very good year, but this has been a very challenging sector to have been invested in for several years. You know, we have had to deal with, uh, slowdowns in China. We've had to deal with pivots in presidential policy. We've had to deal with the rise in us shale, and there's been a lot of disruption. That's caused a lot of volatility. And so energy stock performance, both on an absolute and relative basis has been pretty poor. And so that led to a rotation of the shareholder base from growth investors to value investors. And it took about two years, but those value investors that successfully changed the model of these companies to be growth, seeking, to return seeking, meaning the demand of energy investors globally.

There's not a single investor in the world that wants production growth. What they want to be is paid. They wanna be paid on a quarterly basis, basically of a cash sweep of all of the free cash flow from these shale companies, because at least then they know that they're taking money and, you know, literally putting it into their pocket as opposed to hoping one day the stock prices go up. So it's really, it's the demand of the owners themselves that has led to a change in business models has led to a change in the compensation schemes. You know, the average sale CEO is probably making about 12 to 50 million a year. They used to get paid to grow. Now they're paid to not grow maximize free cash flow and distribute it back to shareholders. So that's, that's a big element. The other element is ESG pressures on the part of the, the eco woke, you know, the, the European global super major who is told that they must reach net zero status by 2050.

And by doing so or to achieve that they must stop growing their oil production, increase cash flow, free cash flow, and not only have to satisfy dividend pavements, you know, to share buybacks, but now they have to invest in renewables. And so you see companies like shell, like BP, they're actually allowing their oil production to fall by about one to 2% per year. And so it's a combination of, you know, poor equity performance leading to a change in the shell co model, combined with ESG pressures, combined with pressures within OPEC countries over the past six years where the oil price has been below their fiscal break, even meaning they've had to sell off crown jewels, literally, you know, steak in Saudi Aramco, et cetera, do bond offerings. So as good as it feels for guys like me, where, you know, I look at $80 plus, and I can model out how much free cash that these companies are generating. Many, in fact, most OPAC countries are just back to breaking even as a sovereign nation. And so they've had the inability to invest in productive capacity. So it's, it's really the culmination of all of those factors that are hurdling us into the energy supply crisis that we find ourselves in.

Without question like is if you're a, if you're a producer of a commodity, you're always at the winds and you, you can hedge short term, you can never really hedge long term and the, the, the nature of the curve or the features curve wouldn't make it, you know, attractive to do so. So as a producer, you really have gotta step back and have a grasp of the fundamentals. And for oil that really revolves around four main things. One is demand both short and long term, you know, short term or back to pre COVID levels. Long term. My expectation is the demand for oil will continue to grow for at least the next decade we can get into that later on and on supply, we touched on it briefly, but the three things that you have to analyze is Usha growth, potential OPEX bear capacity, which I think will be exhausted by the end of this year.

And then the outlook for the global super majors, which is very easy to do so because we know spending from them peaked in 2014 and has fallen subsequently they've harvested all of the projects that were sanctioned in an air of a hundred dollars oil. That was kind of that 2010 to 2014 average. And so it's fairly easy to see how much new production they can bring on relative to the declines that they face every year. And so when you put those four factors together, what it suggests is there's a very strong, fundamental underpinning for the oil, the current oil price of about 82, 83, you know, we're down today off of Bitcoin and NASDAQ weakness and risk off, et cetera. But the, the physical demand for oil remains very strong. The financial market for oil is over 30 times bigger than the physical market. And it remains strong because, you know, there's scoring interest in, you know, growth to value the reflation trade, et cetera. And the, the, the beginning of an awakening of the crisis that we find ourselves in.

Well, early 2020, when, you know, we were all locked in our homes and nobody was flying. And when there was uncertain about what was COVID and how deadly was it gonna be, et cetera, the, the market hates uncertain, as we all know. And so many energy stocks fell by 60, 70, 80, 90% in some cases in the matter of weeks and, and months. I remember one day in early March, when, you know, some of our large Canadian integrated fell by 50% in a single day, like it was just pure panic. And so the role of an investor then was to try to figure out, okay, what's the likely path forward. And secondly, what are these stocks discounting? And, you know, our analysis showed that many of them would have sufficient liquidity to see themselves through this and were they to, you know, make it to the other sides for the valley of death.

You know, we were buying companies where they have 20, 30, 40, 50 years of reserves and maybe I was paying for two of them in the market. And so, you know, you're always making an implicit bet, but you've gotta evaluate the reward versus the risk that you're taking on. And my experience has been that in times of maximum uncertainty, whether it's fear or it's just ignorance as we find ourselves in today for like, what is the truly the, the role of oil in the medium and long term, those are the times that if you can do the analysis and have the liquidity to put to work, that's when you can really make, um, you know, your fortune. So I've, you know, in recent days I've had clients come in, you know, almost apologize for having to start to take down exposure for their clients, cuz some of 'em are up, you know, seven, eight, 900% in, in a year and a half it's only because they saw what we saw. And that was a generational opportunity in energy stocks when everybody was panicking. And of course there was the new normal and nobody would ever drive to work again, et cetera. Those are the times when you should really get excited. It's when you feel queasy in your stomach. That usually that means that there's, there's a generational money making opportunity at hand.

Yeah. My, my earliest mentor is a, uh, self made billionaire that I worked with for many years named Eric SPR. He was the one who really instilled in me as to be a successful money manager. You have to have conviction. You've gotta know that just because, you know, consensus believes something. It doesn't mean that it's right. You know, you've gotta make sure you've got the staying power, your clients, see it as you see, they're not gonna redeem me to death and you, you can't, you can't stand your ground to see the fruition of your call come to pass. But if the analysis you do says that you're right, just because the market moves against you in the short term, doesn't mean, you know, you, you throw in the tele text, sometimes you, you add exposure. Well, I look at I'll just generally say, you know, the biggest opportunity right now is that the market believes that we're all gonna be driving electric cars in two years, none of us are gonna be using oil.

And therefore, you know, the oil industry is a sunset industry. It's, it's heading towards its demise. And yet there are companies, you know, some oil and companies and others. They have 20, 30, 40 years of reserves, but of course the market, you know, how can you put value on something that we're not gonna be using 4, 5, 6, 7 years from now? So as the clouds of energy ignorance part, as people realize that everybody listening to this will be using oil for the rest of their lifetimes. There is tremendous value in long dated reserves that today have literally zero value being placed on them. If I look at I'm a Canadian money manager, I look at the average Canadian company has 15 years of drilling inventory. So it's like they, they freeze widgets and you've got a warehouse. There's no, no risk, 15 years of widgets in this, uh, warehouse.

And yet given how profitable it is to sell widgets right now, all of the free cash flow from selling those, the average Canadian company could entirely privatize themselves with just 3.7 years of free cash flow. So the simple math is, you know, we've got 15 years of inventory. It would only take you 3.7 months rounded to four. The market today is saying there's zero value on 11 years of a free cash flow annuity. And by the way, I think the price of widgets is hitting up and is eventually gonna hit an all time high in the next two to three years. And so what is the opportunity? The opportunities that there is zero value being placed on long dated re resource and gave it in such depressed and depressing frankly, evaluations. You're getting free optionality, not just on where the oil price is today, but where I think it's headed in the quarters and years to come.

Yeah. There's a couple lines like I've you just have to connect the dots mm-hmm and just because other people aren't seeing it doesn't mean that the opportunity is not there and it's, you know, it takes it's some practice, but you can quickly figure out how much cash flow a company can generate at 70 to $80 oil, you can figure out, okay, how much capital do they have to reinvest the production flat, et cetera. And when I look at free cash flow yields of in the large guys, there're over 20% free cash fluid, meaning they could pay a 20% dividend while keeping production flat. And many of them could do that for decades to come in the small cap spectrum, which is where I tend to focus. Cause that's where the biggest dislocations and opportunities exist. I'm buying companies in 25, 30, 40% free cash flow yields, and yet they have decades worth of inventory. So there's a profound dislocation between that. And the only reason for that is the average person on the street. I call it inter ignorance. They just don't know the realities of oil, how it's used, the likely alternatives, how long it's gonna take for those alternatives to displace oil. And so to me, that is why, you know, while energy stocks have performed, well, I still think there's a generational opportunity when you can buy a sector training at a free cash through yield at 20% or higher at the current oil price,

Well, the energy sector, you know, it's volatile. There is, there is risk in single companies. And I would say, if you don't have the experience to know the caliber of management teams, what their background has been, have they monthly, have they not to be able to come through reserve bookings, figure out if they're overly aggressive or not to have the relationships to try to figure out, okay, they're coming catalyst where the street will view this name in a different, more positive light in the coming weeks, months, or quarters. And therefore there could be a rerating there's a tremendous advantage of being able to buy a, you know, diversified basket. I, I would hold 'em 1450 names and elderly diversified. It's not, not a believer in diversification, but to have a little bit of diversification to have active management, continual rebalancing towards those names that are most attractive. Cause as names go up and down like today, things are down 4%. Well, certain names are a lot more relatively attractive than they were the day prior. So to be, have somebody rebalancing that for you and you're not taking on single issue or risk to me, that's, that's a fairly strong, uh, and attractive advantage.

Specifically for energy? My view is this is a multi-year investment thing. This is not a one week trade off of, you know, the, Fed's gonna say X and trade and D whatnot. This is all about how the world is hurtling into an energy crisis because demand is growing. And yet Supplie, isn't keeping up to speed. Inventors are falling prices going up, and yet people are so ignorant that they're not valuing the companies properly. And you know, if we wanna talk about what potential upside for even the current oil price, that loan a hundred and other what they're calling for higher oil prices, there still remains significant upside. I believe in my opinion, in energy stock. So in my mind, this is a five to six year at a minimum investment thesis until you get adequate supply response, um, or demand destruction to balance things off. So that's how I keep it in minded. The energy sector is volatile. You will have down days. This is not something to, you know, over allocate, uh, towards. But when I look at, I believe in the SAP five hundreds, it's maybe 3% weight to me given the risk versus reward. I would personally, I do have a meaning meaningfully higher allocation than, than that.

Yeah. I have no problems with down days because I feel strongly about my call, which is rooted in a deep and thorough analysis that revolves around the macro outlook for the long term demand for oil and then analysis on, okay, well who, who produces it, who's gonna be able to grow. Who's not gonna be able to grow. And when you connect those dots, it tells you that demand, I think will exceed supply growth for the foreseeable future. And we're gonna be running out of this stuff almost, and it's gonna create upwards pricing pressure. And yet companies are committed with 100% conviction to return free cash flow back to investors. And as investors come to realize that that will lead to a rerating in valuations. Cause I'm, I'm buying stocks at two to three times, their enterprise value to their cash flow. When they used to trade at nine I'm buying companies in, you know, 20, 30, 40% free cash flow, such opportunities should not exist. And yet they do. So you can be early sometimes which can be, have its own drawbacks. If it really does test your, your patients and your resolve. But sometimes it's best just to do your analysis, make your call, continue to do the analysis, to make sure that you're not missing something that the call hasn't changed, but so long as it hasn't stick to your guns and, um, just wait for others to see what you see.

You can you just spend the follow me on Twitter, um, at, at Eric model of I've got a video up it's 40 minutes, so it's a bit of an investment of time, but I walk through the thesis, we talk about energy ignorance. How is oil used? What is the alternatives? What's the timeline for those alternatives to gain critical mass. And I think if you spend that time, you'll come to the same conclusion as I have. And then you just have to decide how you wanna take advantage of, of that call.

It's very easy. Do you just go to nine point.com? I E point.com all of the information you could possibly want is there on, on the fund that I manage. And again, I use Twitter very actively to try to communicate, you know, high impact data points and trends and charts. So I try on a daily basis. I don't always do it, but some people find value in that as well.

Happy to spend the time with you.