Commodities outlook: Not your dad’s oil market

In terms of where we are in the energy bull market, we do think this current price cycle has some legs. On the demand side, we’re likely getting into a rate cutting cycle — since earlier this month we saw the Bank of Canada cut rates for the first time in more than four years — which we expect to be stimulative and supportive for oil demand in key economies like the U.S. Over the medium term, demand for oil has largely mirrored both gross domestic product (GDP) and population growth, with both expected to continue their upward ascent and therefore be supportive for oil demand. 

At the same time, we expect the supply side to remain disciplined, with swing producers trying to match supply with demand. We don’t expect oil producers to continue investing in longer term growth to support a market that eventually will be in structural decline. We believe reduced investment in supply will precede falling demand. Therefore, investors should expect the oil market to remain tight when demand eventually peaks and rolls over.

One aspect of the energy market that has us particularly excited is the change in behavior from energy companies to become more shareholder-friendly. Issuers are more focused on balance sheet strength and shareholder returns than on production growth. Free cash flow after investing to maintain operations is being allocated first to reduce debt, then to base dividends and finally to buybacks and special dividends. As debt targets are being met, more capital is being allocated to shareholder returns. We think this theme of capital returns in the energy sector will continue to have legs from here, as companies are generating meaningful free cash flow at current oil prices.

Canada in particular is at a big advantage with this shareholder-friendly strategy being in focus. Canada has some of the most unique supply dynamics in the world. We have the third-largest reserves globally, and the oil sands are responsible for over two-thirds of our overall production. Shale in the U.S. requires consistent discovery, capital expenditure and drilling to maintain production. In contrast, Canadian oil sands production requires significant upfront capital investment. But once the assets are built, they benefit from a minimal production decline rate and a multi-decade runway for production. Canadian energy companies don’t need to invest in new growth initiatives to maintain output, so they’re generating real free cash that can be distributed to shareholders.

With that outlook in mind, we believe there’s a solid fundamental backdrop to invest in the Canadian energy sector and believe a balanced portfolio should have an allocation to Canadian energy. 

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