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After rising over 30 percent this year, WTI prices plummeted this week as a rising U.S. dollar, rising U.S. crude inventories, and fresh setbacks in vaccination programs in Europe weighed on the market. Kim Parlee speaks with Michael O’Brien, Portfolio Manager, TD Asset Management.
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- I want to start with just, are you surprised at the rapid rise that we have seen in oil prices so far this year?
- Yeah, actually I am, Kim. If you had asked me nine months ago if I thought we'd be sitting here with oil in the mid-60s, I would have said, no way. So it's been a pleasant surprise, yes. It's been more work done on the supply side than on the demand side. But right now, this is a very healthy oil price for North American producers.
- Well, let's dissect that if we could then and talk about supply and demand. I'll start with the demand side. It sounds as though this is not as much a demand story, in terms of what they're looking forward to, but what are you seeing on the demand side?
- Well, it's encouraging. It will be a demand story later this year, once the economy opens back up. I think that was always the expectation, was everybody would breathe a sigh of relief once you saw people flying and traveling and moving around again. Once we start to see those, the oil demand number will head back towards that 100 million barrel a day mark that was sort of pre-pandemic.
But really, the story in terms of why the oil prices firmed up a lot quicker than people expected, it's been more of a supply-driven event, where OPEC, in contrast to what they did a year ago, when they pulled the rug out from under the oil market and flooded the market just when people didn't need the oil, lately they've been very good stewards. And they've made no secret of the fact that they're trying to keep the market tight and work down some of those excess inventories. So it's become a much more constructive stewardship of the market on behalf of OPEC, I would say.
- How long do you expect that stewardship to last?
- Well, I think as demand begins to come back-- and we are seeing that. I think some of the more recent data, or very recent data out of the US in terms of the number of people boarding flights, for example, it's encouraging. Things are trending in the right direction. I think the more demand comes back, the easier it is, frankly, for OPEC to stick to its guns, because what they really want is-- as the pie gets bigger, then it becomes much easier to talk about who gets what share.
Where it was really difficult last year is when the pie was shrinking so rapidly, when demand was contracting so fast, and nobody could get something that made them feel good about where they were at in the oil market. So I think if we do see the economies opening up and we get the kind of growth acceleration that I think most people are expecting, I think it's going to be-- it's going to create a scenario where OPEC will be able to release this supply back into the market in a very orderly fashion. It should be very constructive for the markets, if we can pull that balancing act off.
- If OPEC releases more supply into the market, what do you see in terms of other suppliers? I mean things like US shale, even oil sands. I mean, as things start to stabilize, is that something that we need to be watching from a supply standpoint?
- Well, I think this goes to the heart of the Bull thesis from an investor perspective for energy stocks, as opposed to the oil price. Like make no mistake about it, oil in the mid-60s? Canadian and US producers can make good money here.
I think what's really important is there seems to have been a real behavioral change in the attitudes of the management teams and, specifically, south of the border with US shale. After seven years or so of this, drill baby, drill, kind of mentality, investors completely turned on those companies. And investors made it very clear that they did not want their investment dollars being recycled into more drilling and more production. What they wanted was investment returns. They wanted dividends and share buybacks.
And so what we're seeing so far is, as the oil prices firmed up-- it got through $50, it got through $60-- we're not seeing massive numbers of oil rigs coming back on. We're not seeing all those signs that would indicate we're going to have a boom in production. So at least for now, the US and Canadian producers seem to have reversed-- the behavior has changed towards a focus on generate free cash flow, return this to investors, as opposed to grow production. Because for the last 5 or 10 years, nobody has been rewarded for that strategy.
- Hmm. It's interesting. When I hear you say, at least for now, I feel as though there's an asterisk there.
- Right.
- We might have to come back and revisit if production ramps up. But that does sound encouraging. Michael, I've only got about 30 seconds left. But just given that scenario you've painted, what do you see for oil prices over the next 6 to 12 months?
- I think there's more upside than downside here, but I don't want to get carried away. Until we see demand back at that 100 million barrel a day plus level, there is always going to be the risk that the Saudis or the Russians or somebody threw us a curveball here or something unexpected happened. So the way I'm kind of looking at it is we're feeling constructive about this. But if we can keep this oil price stable in the $60, $65, $70 range for the next couple of quarters while demand firms up and the economies reopen, then I think these stocks should do really well.
- Mike, great to have you with us. Thanks so much.
- Thanks, Kim.
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- Yeah, actually I am, Kim. If you had asked me nine months ago if I thought we'd be sitting here with oil in the mid-60s, I would have said, no way. So it's been a pleasant surprise, yes. It's been more work done on the supply side than on the demand side. But right now, this is a very healthy oil price for North American producers.
- Well, let's dissect that if we could then and talk about supply and demand. I'll start with the demand side. It sounds as though this is not as much a demand story, in terms of what they're looking forward to, but what are you seeing on the demand side?
- Well, it's encouraging. It will be a demand story later this year, once the economy opens back up. I think that was always the expectation, was everybody would breathe a sigh of relief once you saw people flying and traveling and moving around again. Once we start to see those, the oil demand number will head back towards that 100 million barrel a day mark that was sort of pre-pandemic.
But really, the story in terms of why the oil prices firmed up a lot quicker than people expected, it's been more of a supply-driven event, where OPEC, in contrast to what they did a year ago, when they pulled the rug out from under the oil market and flooded the market just when people didn't need the oil, lately they've been very good stewards. And they've made no secret of the fact that they're trying to keep the market tight and work down some of those excess inventories. So it's become a much more constructive stewardship of the market on behalf of OPEC, I would say.
- How long do you expect that stewardship to last?
- Well, I think as demand begins to come back-- and we are seeing that. I think some of the more recent data, or very recent data out of the US in terms of the number of people boarding flights, for example, it's encouraging. Things are trending in the right direction. I think the more demand comes back, the easier it is, frankly, for OPEC to stick to its guns, because what they really want is-- as the pie gets bigger, then it becomes much easier to talk about who gets what share.
Where it was really difficult last year is when the pie was shrinking so rapidly, when demand was contracting so fast, and nobody could get something that made them feel good about where they were at in the oil market. So I think if we do see the economies opening up and we get the kind of growth acceleration that I think most people are expecting, I think it's going to be-- it's going to create a scenario where OPEC will be able to release this supply back into the market in a very orderly fashion. It should be very constructive for the markets, if we can pull that balancing act off.
- If OPEC releases more supply into the market, what do you see in terms of other suppliers? I mean things like US shale, even oil sands. I mean, as things start to stabilize, is that something that we need to be watching from a supply standpoint?
- Well, I think this goes to the heart of the Bull thesis from an investor perspective for energy stocks, as opposed to the oil price. Like make no mistake about it, oil in the mid-60s? Canadian and US producers can make good money here.
I think what's really important is there seems to have been a real behavioral change in the attitudes of the management teams and, specifically, south of the border with US shale. After seven years or so of this, drill baby, drill, kind of mentality, investors completely turned on those companies. And investors made it very clear that they did not want their investment dollars being recycled into more drilling and more production. What they wanted was investment returns. They wanted dividends and share buybacks.
And so what we're seeing so far is, as the oil prices firmed up-- it got through $50, it got through $60-- we're not seeing massive numbers of oil rigs coming back on. We're not seeing all those signs that would indicate we're going to have a boom in production. So at least for now, the US and Canadian producers seem to have reversed-- the behavior has changed towards a focus on generate free cash flow, return this to investors, as opposed to grow production. Because for the last 5 or 10 years, nobody has been rewarded for that strategy.
- Hmm. It's interesting. When I hear you say, at least for now, I feel as though there's an asterisk there.
- Right.
- We might have to come back and revisit if production ramps up. But that does sound encouraging. Michael, I've only got about 30 seconds left. But just given that scenario you've painted, what do you see for oil prices over the next 6 to 12 months?
- I think there's more upside than downside here, but I don't want to get carried away. Until we see demand back at that 100 million barrel a day plus level, there is always going to be the risk that the Saudis or the Russians or somebody threw us a curveball here or something unexpected happened. So the way I'm kind of looking at it is we're feeling constructive about this. But if we can keep this oil price stable in the $60, $65, $70 range for the next couple of quarters while demand firms up and the economies reopen, then I think these stocks should do really well.
- Mike, great to have you with us. Thanks so much.
- Thanks, Kim.
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