How one outperforming energy investor is playing the jump in oil prices

Published Sat, Oct 23 20218:48 AM EDT

By all accounts traditional energy investors — those targeting oil and gas companies — are having a good year. West Texas Intermediate crude oil broke above $84 on Wednesday for the first time in seven years, and the energy sector is far and away the top-performing S & P 500 group this year. The gains do, of course, follow years of underperformance as investors fled the sector. But 2021's return is notable nonetheless. And one market-beating portfolio manager believes the group is just getting started. Eric Nuttall, senior portfolio manager at Ninepoint Partners, which has roughly $6.5 billion in assets under management, believes ongoing demand coupled with constrained supply will push oil above $100 next year, and to a new all-time high between $140 and $150 over the next few years. Energy companies will, in turn, reap the rewards. Others, however, are less optimistic about the long-term picture. The International Energy Agency said this month in its annual World Energy Outlook that oil demand could peak by the middle of the decade. Nuttall's energy-focused fund has returned 142% this year and nearly 300% over the last year, on a compounded basis. That tops the Canadian energy sector, which has returned 72% this year. The U.S. energy sector, by comparison, is up 54% for 2021. "The biggest challenge for energy investors today is that everything looks good," Nuttall said. Still, he prefers Canadian oil names given that they trade at a discount to their U.S. peers. His highest-conviction name is currently Cenovus Energy . The company has focused on deleveraging over the last year, which should allow them to "mount a really aggressive share buyback initiative." He believes the company could ultimately buy back 15% of its outstanding shares, which would lead to a re-rating of the stock. Shares of the company are up 87% this year, and nearly 200% over the last year. Oil's had a record-breaking year and now trades at pre-pandemic levels, but the scars of 2020, and the demand destruction that Covid brought, remain. Companies cut capital spending plans, shored up balance sheets and focused on shareholder returns. Nuttall said there's no going back to old business models that supported drilling at any cost. "Discipline is the new normal. The business models of old are obsolete, broken and will never return," he argued. Looking forward, it will be about spending enough to maintain flat production, with the majority of the remaining free cash flow going back to investors. "It's imperative — to bring investors back — to not repeat the sins of the past by chasing production growth," he said. Ultimately this means the landscape is very different than a decade ago. Back then, when oil prices jumped U.S. shale producers would ramp up production, effectively putting an end to high oil prices by flooding the market. But that's no longer an option. And yet despite the energy sector trouncing other sectors this year, it remains undrowned. Investors shifted allocation to growth areas of the market, while also avoiding energy names over ESG concerns. But Nuttell said buyers will return, it just all comes down to time. Once the market is confident that oil can reach a level of stability, investors will re-enter the space. "We've passed the point where the fear of missing out is too great for the generalist investor to continue to ignore this sector," he said. In addition to Cenovus, another name Nuttall is watching is Suncor , which has returned just 32% in 2021. The company is underperforming the price of oil itself, which has surged more than 70% this year. "It's been a complete dog this year...their execution has been short of stellar," he said of the company. But this means expectations are now so low that the company can "pretty handily" beat estimates so long as they're able to regain their stride. On the flip side, he recently sold Pioneer Natural Resources, Diamondback Energy and Devon Energy in an effort to re-allocate capital to Canadian companies.

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