Weekly Update 02/12/2021

Feb 12, 2021 | Travis Stringer


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Increasing confidence that the pandemic is under control and that a very robust economic and earnings recovery will soon be upon us has been the narrative in the global equity markets over the past few weeks. One of the best performing sectors so far this year has been global energy. Despite some long-term headwinds that remain very much in place, the supply and demand dynamics that are typically responsible for the price of oil are beginning to look more constructive than they have in years. We explain a bit more below.

Coronavirus Update
North America continues to see a meaningful decline in infection trends. In Canada, the 7-day average rate of new daily infections fell, but the magnitude was noticeably less than the last few weeks. The figure now stands at close to 3500 new daily cases versus the 4000 from the week ago period. Many provinces are experiencing declines, but Newfoundland is grappling with its largest outbreak since the pandemic began, while Nunavut has also seen an increase. In the U.S., the 7-day average rate of new daily cases fell to close to 95,000 versus the 120,000 from the prior week.

The turn lower across the globe over the past few weeks has been encouraging. But, a third wave (or fourth in the case of the U.S.) remains a distinct possibility. The Spanish Flu of 1918-1919, which has often been used as a comparison, followed such a pattern, though fortunately its third wave was not as severe. It is hard to predict the path of this virus, but investors will undoubtedly be on guard. Fortunately, the pace of global vaccinations is expected to accelerate in the weeks and months ahead.

Energy – some relief, for now
The global energy industry has faced some difficult times. The headwinds began nearly a decade ago: the rise of U.S. shale production that led to a significant increase in supply. More recent has been the growing investor focus on sustainability with a particular emphasis on climate change and the environment that has created another powerful headwind. Then last year, the arrival of the pandemic resulted in an immediate and dramatic destruction of demand for oil as governments were quick to shutter parts of their economy. As if that wasn’t bad enough, Saudi Arabia and Russia, two of the world’s largest producers of oil, entered into a spat over production and market share. Ultimately, the combination of these latter developments resulted in oil prices going negative for the first time on record for a brief period nearly a year ago. An additional challenge for Canada has been the lack of pipeline capacity that has resulted in a long lasting discount in the price of a Canadian barrel of oil.

But, as with many things, time has a tendency of healing some wounds. Oil prices have bounced back. The global energy sector has led equity markets higher year-to-date. The anticipated recovery from the Covid-19 pandemic has much to do with it as investors expect a vigorous rebound in oil demand driven by the reopening of the global economy through the second half of the year. More importantly, there are supply considerations that could lead to a constructive outlook beyond this year.

There has been significant underinvestment on the part of energy producers around the world in recent years. Most have scaled back their capital expenditures, particularly around new projects in the wake of the weak oil price environment. It could lead to a situation where demand outstrips supply over the next few years. Rising demand combined with limited supply could provide more supportive conditions for energy prices.

Some capital will inevitably return under a more favourable pricing environment. But, there are a number of reasons to believe that the elasticity of supply will not be what it once was. First, the U.S. shale industry has undergone a period of consolidation, and many are now seemingly prioritizing free cash flow, balance sheet health, and capital discipline with a focus on returning capital back to shareholders over producing higher levels of oil. Moreover, access to funding may be more challenging and costly in a political backdrop where carbon emissions are a priority for the U.S. administration. Furthermore, climate change, the environment, and broader sustainability continue to be key issues for lenders and investors alike, suggesting that capital may not be as widely accessible for oil producers at the global level relative to the past.

The wildcard may be OPEC, as has often been the case. The international consortium of 13 oil producing nations, led by Saudi Arabia, has significant influence over the oil market as its decision to raise or lower production often drives the near-term direction of prices. And it has sometimes been unpredictable in its behaviour. Over the past year, it has shown a willingness to sacrifice its own production and accommodate other countries for the sake of price stability. While this has proven to be supportive for the oil markets, it is hard to predict if this will remain its approach going forward.

It appears that the ingredients – supply and demand – for a more constructive outlook for oil over the intermediate term may be falling into place. That will come as a welcome relief to the energy sector. Yet, some meaningful longer-term challenges remain. The world is trying harder than ever before to transition away from fossil fuels and into more renewable sources of energy. It is hard to imagine that trend abating. Yet, it will take time. Moreover, oil has many uses beyond being a primary fuel source. Electric vehicles for example depend on oil in the form of the plastic content used to ensure the vehicles are as light as possible. While there is no denying the secular headwinds that exist, the outlook is more nuanced than it may appear.


We are pleased to share the latest investment strategy report from RBC Wealth Management: Global Insight Weekly.

Highlights:
A “meme stock” moment, or more?

Amid the postmortem on the GameStop saga, some investor unease is lingering. We do think the episode is indicative of a megashift at play—one that is bigger than the stock market. But at the same time, we don’t think the meme stock phenomenon is a serious threat to traditional investment portfolios.
Regional developments: Canadian equities post healthy gains across most sectors; U.S. economic data supports continued Fed accommodation; Miners and Tech outperform in Europe; Tariffs on Chinese goods remain in place for now

Contact us today to discuss any wealth planning topics or investment ideas. We appreciate the opportunity to serve you and are honoured to help residents of Northern BC accomplish their long-term financial goals.