Managing Director and Head of Dynamic Funds
Vice President and Portfolio Manager
Mark Brisley: You are tuning in to On the Money with Dynamic Funds, a podcast series that delivers access to some of the industry's most experienced active managers and thought leaders. We're sitting down to ask them the pertinent questions, to find out their insights on the market environment and navigating the investment landscape.
Welcome to another edition of On the Money. I'm your host, Mark Brisley. As the world comes out of the pandemic being our singular daily focus, our attention is now focused squarely on the unavoidable daily headlines of inflation, supply chains, and energy prices. It feels very real that the economic recovery globally is leading to shortages of just about every aspect of goods, services, and materials.
Supply chain disruptions have been the front and centre topics since the onset of COVID, and now, through the recovery. That's being pointed to as a source of the inflation pressures we're seeing right now. The focus for many of us is in areas we see tangibly every day. At the forefront, currently, that's the stress of rising energy prices. Oil has recovered its pre-COVID levels and tacked on nearly another $20. At the same time, natural gas has risen to an even greater extent, more than doubling its 2021 low.
My guest today, Jennifer Stevenson, portfolio manager here at Dynamic, and based out of the heart of the Canadian energy industry in Calgary, which makes her close to the companies she covers and also through her regular travel on the ground and other major global energy hubs. Jenn's extensive energy industry experience spans nearly three decades, and she's fostered a global approach to casting a wide net in search of the highest quality companies with solid management teams and sustainable long-term business models.
Today, we wanted to bring the energy discussion into real and understandable terms, because when you're standing at the gas pump or paying your heating bills, you're not thinking about the issues of WTI or Brent Crude. You're probably thinking, "WTF." Jenn, welcome, and thanks for joining me today. I'm just going to jump right in and talk about what are the primary drivers we're seeing in these energy price increases in energy markets right now.
Jennifer Stevenson: Oil is different from natural gas, but the biggest issue with oil prices right now comes down to supply and demand. We had massive contraction in demand with the onset of COVID. We all witnessed oil prices crash and then, in fact, WTI went negative on the futures contract. That massive collapse in demand created a dearth of cash flow, it created a massive contraction in capital spending, and we don't have the supply growth from our usual sources. We still have supply. OPEC has spare capacity, but OPEC has been very disciplined about methodically returning that spare capacity to the market to try and shore up and make more healthy, a.k.a. higher, the oil price.
We've had demand rebound sharply as COVID has become better and travel, mobility is increasing, demand for goods and services is increasing and everything requires energy. You've got this contraction in supply growth and spending, coupled with a recovery that was quite sharp in demand, OPEC bridging the gap to a point but wanting to make sure that prices are strong enough that it's profitable for their member states to continue to add that spare capacity. Where we used to have growth before from the quick supply response areas like US shale, we just do not have that capital being put in the ground to create that growth because that's not what shareholders want.
Mark Brisley: Jenn, one of the more troubling headlines circling around right now is that we're potentially looking at an energy crisis. You don't have to go very far to find the news. I was looking at articles this morning, talking about street lights shutting off and factories shutting down. In reality, there's a recent shortage of gas in the UK being reported, soaring natural gas prices affecting Europe, India running the risk of mass blackouts. Are these just localized issues or are these real symptoms of a larger issue in energy markets?
Jennifer Steveson: The headlines are disturbing, but the headlines also are-- I always find them quite inflammatory because that's what gets clicks or papers sold or whatever the delivery mechanism is. If you just think about what's going on, there are high natural gas prices right now. The issue with gasoline, diesel, petrol in the UK, that's not a supply of the product globally issue at all. That's a regional issue because we have gasoline and diesel, but the issue is getting it to the petrol stations in the UK because it needs to go by truck, and they don't have the truck drivers.
Part of it is some of the labor shortage that we see in various industries as we work our way out of COVID and out of government wage subsidies, but in the UK, it's really exacerbated by Brexit because the trucking industry is an industry that has employed a lot of foreign nationals and they're unable to be in the country working and therefore we're short thousands of those supply service providers. That means that there's gas stations that don't have any gas, petrol stations that don't have any petrol. What happens is that you hear that, and what do you do? You instantly go fill up with gas, just like everybody went and bought a whole year's supply of toilet paper when COVID started and there was toilet paper shortages. The gasoline thing in the UK is mostly Brexit and it's fixable. The natural gas situation has been a while in coming because Europe last year had a cold winter and they drew down their storage levels of natural gas as a result. Fine, that happens when it's cold, but they haven't filled them back up to levels that were comfortable heading into this winter because, in the meantime, Asia had a hot summer, so there was a lot of demand for natural gas over there. Prices were higher. European utilities didn't want to pay those prices to put the gas in storage. That's one issue was price, and now that we're heading into winter, it's still price.
The other factor that's going on is Europe also gets natural gas from Russia. There's pipelines that go through the Ukraine and supply is not being added to those because there's a new pipeline from Russia that goes to Germany and it's called Nord Stream 2, and it's fully built. It's full of natural gas, which means if you put some molecules in at the Russia end you get some out right away at the Germany end. It's the line pack is in there. It's full of gas, but it's not flowing because it needs approval from Germany, from the government, and it needs approval from the EU.
Germany just had an election and they're putting a coalition government together. Then the question is, what does that government do? They need the gas but there's a Green Party component to that coalition, so that's up in the air. The EU approval is up in the air. Putin has said, we're not sending gas through there unless it's approved. There's a solution to that, but that's political. In the meantime, there's demand for natural gas and the prices are high. Where cutbacks can happen, like dimming streetlights or factories not running as much to burn less natural gas, that's going on.
We're also seeing, because natural gas in Europe right now is more expensive than oil, we're actually seeing some substitution in power plants to burn oil instead of burning natural gas to get through this short-term issue. We've also seen increased coal demand to get through this short-term issue in Europe, which is basically winter because there's more supplies coming on from LNG projects globally. Two of them are in America but they're not coming on ahead of the EU winter. That's regional and localized, but it's definitely headline news right now and is impactful right now.
Mark Brisley: I mentioned at the top that top of mind now is inflation and it's in the news, we're hearing about it, but let's think about it in terms of energy inflation. I guess the question is does energy inflation pinch a consumer's pocketbook differently than regular inflation, and whether or not we think this is transitory or permanent levels of inflation, do you actually think that's going to get to a level where this is going to change consumer behaviour? Where mom and dad are saying we're not going for that drive, or I'm not going to take the car out this weekend here or there?
Jennifer Steveson: That's a good question. Mark, you and I are both old enough that we can remember times when gasoline prices were what seemed to be insanely high. What do we do? When you look at the data when energy prices are high, and you look at the consumer behaviour, energy prices have to be exorbitant, higher than today by a lot, like oil needs to be $100 for a significant period of time before we see any impact in consumer behaviour. What changes when a bigger slice of your budget is going to fuel either your home heating or your car, is that you make changes in other areas. You make changes in other expenditures and you make brand changes. Maybe instead of buying Kraft peanut butter, you buy Super Brand or whatever. We don't see the energy inflation impacting the energy demand.
Energy is one of those things, oil and gas, where you actually have a really inelastic relationship. in elastic means it doesn't change. Most things, the price goes up, the demand goes down. Energy, the demand stays pretty constant and continues to grow a little bit every year, even though the price goes up because it is something that is that essential. Are you not going to drive your kid to their hockey game? Are you not going to drive out to your friend's cottage for the weekend because gasoline is a $1.75 a litre versus a $1.25 a litre?
Mark Brisley: This is just an observation, but it's interesting because I've noticed as I've started to commute a little bit more again, I'm realizing in major cities, you're seeing less people take public transit, and there's still some of that global pandemic fear baked into that. As a portfolio manager looking at energy, do you look at that side of it as well? Where this whole fear and mass transit, and people being in condensed spaces might actually drive more people into fossil fuel using cars and that type of thing?
Jennifer Steveson: Yes that's a good observation because we've certainly seen that through part of the pandemic that when the mobility has increased, it's been private mobility as opposed to public transit because of the COVID contagion fear. We have seen things like car sales in China last year went up because people wanted a private vehicle and not mass transit. There's definitely an increase in demand for that mobility piece as opposed to public transit. Then over time, I think we'll see that mobility piece move into more electrification, but again, we've got the demand today for that mobility, personalized internal combustion engine, and over time it moves to batteries. It's not an overnight sensation.
The other thing on the mobility front that is happening that affects oil is that we haven't been flying. As countries open up, I mean, the US and Canada have always been open for flights, but starting November 8th, we can drive back and forth, and people start to get more comfortable with flying on an airplane. That might make them more comfortable with mass transit. Certainly, they want to go on a vacation, so we see that increased demand for jet fuel, which comes from oil. We see that trickling into oil demand going forward as well.
Mark Brisley: There's no question we're feeling tangibly daily things like higher prices at the pumps. If we're also looking at higher natural gas prices, that I guess could mean we're looking at higher heating bills this coming winter. Now, from a purely selfish point of view or a consumer point of view, is there hope that some of these issues might subside or come down as we head into winter holiday season? How are consumers thinking about this?
Jennifer Steveson: With North America, we have cold weather in the winter, and demand for natural gas is weather-dependent. Natural gas prices have softened in October because it wasn't cold yet. That big Hurricane Ida that hit the US Gulf Coast that had knocked out some oil and gas supply, but gas in particular, that stuff's back on so that helps supply. I don't see anything near-term for natural gas because winter will come. Every year, winter comes, and every year, there's a period of time when it's cold, and every year, we need natural gas to meet that weather-related heating demand. That's going to happen this year and if it's cold at Christmas, we will have higher natural gas prices.
What the Europeans are doing right now in the face of the exact same thing, and they're paying way higher prices than we are because they import so much gas and it's liquified natural gas, and we talked about what's going on with those dynamics already, but what the European governments are doing is subsidizing either the utilities or the customers themselves to get them through this period of high prices because this is not a structural change. This is something that we can see after we get through the winter, we can see more LNG from some few new projects, and we can see natural gas supplies meeting demand outside of the winter months. It's not as much of an issue in North America versus Europe. Our prices are certainly higher, but it's nothing like Europe is.
Mark Brisley: I'm going to ask you a question about a conversation we've had many times before, you and I, and I think all of this is showing just how reliant the world still is on fossil fuels. I'm wondering, does this muddle the case for aggressive climate action? There seems to be a big difference right now between energy today and energy aspirationally, and has this brought some realities into the picture?
Jennifer Steveson: COP26, so that's the Council of Parties, which is basically the United Nations meeting on climate change. That happens October 31st to November 12th, so coming up in two weeks, and that's when the 154 or however many countries that signed the UN deal on climate change to keep global temperatures from rising no more than 1.5, maybe 2 degrees, they all have to reaffirm, demonstrate their commitments. There's a lot of commitments being made, but the politicians I find are really great at saying, "Yes, this is all going to happen."
They don't listen, I think, to the scientists who say, "Yes, this is all going to happen, but here's how we need to get there," because it's an energy transition, it's not an energy flip the switch. We can't just say all of the electrical generation is going to be wind and solar by 2025. It's 2021 and three quarters now. The renewables are super cost-effective. They're profitable for the companies doing them. They're big growth areas, yes, but those need to be balanced with the need for reliability. Until we can build the storage to store those generated electrons, we need things like nuclear or we need things like natural gas to provide that baseload and that reliability.
I think there'll be lots and lots of headlines coming up with COP26, which is that UN climate meeting and it's being held in Glasgow, Scotland. The thing I'm hoping to see from that is some realism as to the pace and some acceptance about things like natural gas, for example, being needed as a bridge fuel as we move through this transition. Because the growth in renewables is there, the technology is valid, but the requirement for hydrocarbons, for simple necessary things like mobility and heat is not disappearing anytime soon. That needs to be recognized and accepted and adapted into the plans.
Because there's things we can do with hydrocarbons like carbon capture and storage, like direct air capture of CO2, like making sure that we're not leaking methane to still use hydrocarbons but do it in such a way that we're able to meet those Paris Climate Agreement goals of that maximum 1.5, 2 degrees of warming.
Mark Brisley: Not wanting to dive into the political aspects but, if we're being honest Biden, for example, in the US, ran on one of the most aggressive political climate change agendas in history. Does all of this make it a little harder for him to get some of that spending passed? From a portfolio management standpoint, there's a lot of opportunities coming out of the significant investment that they were going to be making in climate change and clean energy, including some of the targets they've set for themselves. Where does that leave someone to think about the US influence as a world leader in this particular arena?
Jennifer Steveson: Biden certainly campaigned very much on a climate agenda. He's got John Kerry as his climate czar. They are very, very focused on meeting their green agenda, their clean energy agenda. I think these bills get passed, and there's so much negotiation politically that goes on with whatever else any individual member of the House down there can put in those bills, but there's an infrastructure bill, and there's a budget reconciliation bill that has a whole bunch of infrastructure and clean energy components to it. I do think that those get passed in some measure and quite frankly, whether they're $2 trillion or $3 trillion, it doesn't really matter as much as they get passed, and that just green lights a massive amount of development and spending on those sectors and in those industries.
Then individual states have got a lot of autonomy in the US. You see places like California already moving forward on extending the tax credit for wind, extending the tax credit for solar, working on expanding the grid, talking about interfacing grids with neighbouring states. More so that a problem in California can be fixed by a solution in Oregon or Washington or Idaho, that can get the power over to California, because the US is really regionalized. If you think of that ice storm in Texas last year, one of the problems is Texas is like an island. When there's a problem in Texas with the electric grid, no one else can help them. That kind of thing is underway and being changed and that doesn't need Senate or Congressional bills and support to go ahead because that can all be done at the state level. There's lots going on there for sure.
Mark Brisley: Let's zoom out a little here and take a look at a bigger picture and that is around the question of what does the longer-term supply-demand dynamic look like for oil?
Jennifer Steveson: Yes, longer term's interesting because right now the oil companies around the world, let's say, everybody who's not an OPEC country, they have been through many, many, many years of growth and spending and not the performance that they would've expected in their shares or not the performance in the oil price if they're a national oil company. Now they're at the point where they completely embrace discipline with their capital, which means that they're all generating huge amounts of cash flow right now because oil and natural gas prices are high. What they're not doing with those amounts of cash flow is drilling a whole bunch more wells. They'll drill more wells to maintain their production, but they're not drilling to grow.
When you look at the long term for oil, for example, structurally what we've got is some spare capacity still at OPEC; that they meet every month and every month they decide whether they should produce more or less and the last few months they're producing every month they add another 400,000 barrels a day, and they've got some more spare capacity that they can put on the market and then they're tapped out. The rest of the world is not spending to grow, they're spending to maintain.
I think we're at a place here where energy prices, where they are now, and we could say quite comfortably plus or minus $5, $8, $10 can be the new band as we go through this transition. I think that band is quite long-lasting because the transition will take time. There's tremendous growth within it from the renewables, but we also have the demand for the legacy oil and natural gas production. Even as that demand slows over time, we don't have growth in supply, so that will support prices over time. My long-term view for oil prices is quite constructive. I don't think oil prices are going to $40 in the next 10 years because of the supply-demand dynamic that's going on and the responsible use of capital.
Mark Brisley: When we think of energy here at home, domestically, it's pretty hard not to think about pipelines. Is it possible that higher oil prices would put pressure, specifically on the Biden administration as an example, to be more open to building out their pipeline capacity with Canada?
Jennifer Steveson: Yes. Biden campaigns on killing Keystone, which he did right away when he got into office. Keystone XL, being the pipeline that the TC Energy was building, to go from Canada to Cushing, Oklahoma. They've already built the part from Cushing down to the US Gulf Coast. Biden comes in and revokes the previously issued Presidential permit, that's not a nice thing to do to your neighbour. However, he does that and all prices go up for the reasons that we've discussed, with the COVID recovery and the lag on supply from no capital spending, and he phones OPEC and says, "Can you send more oil?"
He talks to the US producers and says, "Can you produce more oil?" When he could've had it from Canada, and the thing with Canadian oil is, it's that heavier gravity which means if you pour it out of a bucket, it looks more like molasses than gasoline, it's thicker, it's heavy. That's what US refineries really, really like. They get it from Canada, they used to get it from Venezuela, they still get a bit from Mexico. That's what they're designed for, that's how they make the best yield and the most money. The US Shale guys, producing more really light crude that looks more like gasoline, that doesn't help the US refineries.
When the politics gets in and prices are high and they've already canceled pipelines, I don't think the pipeline discussion comes up ever again. There's a dispute between Canada and the US about Line 5, which is an Enbridge pipeline that crosses the Straits of Mackinac in Ontario but there's workarounds for that so that governments can just figure that out and that's a whole bunch of politics, a whole bunch. With the Governor of Michigan, blah-blah-blah.
When we think about pipelines, I don't think there's any more pipelines built, when Enbridge expanded and replaced Line 3, which is the big Enbridge lines that go from Canada, again, down to the US, when they replaced that pipeline, it's a 60-year-old pipeline, so they replaced it. That's a safety thing, that's a smart thing to do. It took forever to get it all approved and done but it's done, it's in service, and it's a bigger capacity now than it was.
With Enbridge Line 3 replacement, with the TMX pipeline being built, with additions that Keystone and Enbridge have made to pumping capacity and using additives with the oil that allow it to flow more freely down the pipeline, you can increase the volume. All of those things have added to Canada's pipeline export capacity. TMX goes to the Canadian West Coast so we can get those barrels to places like Asia, which is fantastic, but we’re not in need of more pipeline capacity in Canada now. That issue that's plagued us for years and years and years; we're good. Biden not allowing Keystone XL to go ahead, that was rude but it's not being revisited. We're good. We've got enough.
The US politically always worries about gasoline prices. This is going to be topical because US midterm elections are coming up and US gasoline prices are really close or over, depending on where you are and what grade of gasoline you're buying to $4 a gallon, which is a big deal. What you could see the US do is something like releasing oil from their SPR, and SPR just means Strategic Petroleum Reserve.
They will do that when this happens; when there's high oil prices, when there's high gasoline prices. It's always before something like an election or a midterm election, and they release fuel from the SPR with a goal to reducing oil prices in America so that gasoline prices go down and basically it's never effective. If it is, it's effective for about an hour but you'll see lots of talk about that and for sure in my view, you'll see those volumes come out, but it's always fun to watch. US politics is very entertaining for the energy sector, right?
Mark Brisley: Indeed. When we're not saturated with it, it is. One last question for you, Jenn. As a portfolio manager, you invest across the spectrum of categories within the energy sector and you talked about changing consumer demand when it came to how we use transit and those types of things. I'm wondering, we've said often that the pandemic was an accelerant for a lot of things. I'm thinking about solar as an example or green hydrogen and also consumer behaviour. How long do energy prices have to stay high where people heating their homes gets them starting to think about heat pumps and the solar panels on the roof? Where are we in that conversation?
Jennifer Steveson: I wish that we can get to a place in Canada where it's like California, at least as far as the solar industry is concerned. Because in places like California, you can get in some places, some counties, an upfront grant, you can always get a tax incentive and you can put a solar system on your house, and the solar system means you've got panels on your roof. You have got an inverter either on your roof or on the wall in your garage, you've got battery storage, and you run your house on your solar and you get net metering, which means that, if you are generating more kilowatts than you're using, you can choose to either store it, fill up your batteries, or you could sell it, or some of it, back to the grid and get paid.
If you ever need anything from the grid, you're paying net. With that whole system, the panels, the inverter, the storage, you can become grid-independent when you have enough storage and you have enough panels and you've got monetary incentives to do that. That's really appealing as a consumer and then you think, oh, but maybe I don't want to spend however many thousand dollars for what you need on my existing home. You look in California at new residential development, they're putting this in the whole neighbourhood.
Then you think about the utility and the utility is still connected to these houses. All of these houses have solar generation and storage, which means that then the utility can use that as backup on its network. It's like a distributed grid of generation and storage. The user, like you and I, can control all of this on an app on our phone. You can decide, I'm not going to send any to utility or I'm going to allow them to take up to 50% of what I generate as long as my batteries are 80% full. You've got that independence and flexibility and it's really empowering and it also gives people a lot of comfort that I can always charge my vehicle, I can be independent of an outage from a storm or a fire.
I think it does help to have some tax incentives from the government to allay that initial cost, but the build-out of that from a residential standpoint, I think will really continue to grow. I would like to see that become easier for Canadians to do. Because the technology is such that it's fine if you live where I do where it's sunny, but it snows and it's cold. The panels work, the batteries work, it's all usable. I think that's a big growth area going forward that is tangible that we can see and covet.
Mark Brisley: Jenn, we've unpacked a lot here in this discussion and I want to thank you for that because it's been super informative and it's a subject, it touches all of us tangibly in just about every aspect of our lives. Appreciate your insights and for joining us today. Thanks to everybody that joined us today as well, we're happy to have Jenn here as regularly as it's necessary because it's a subject that continues to evolve. Of course, you can check out any of our On the Money episodes, on both Apple and Spotify. I want to thank all of you for joining us. On behalf of everybody at Dynamic Funds, we continue to wish all of you good health and safety.
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