Natural gas, oil and coal prices have all been surging to multi-year highs. Kim Parlee speaks with Hussein Allidina, Head of Commodities at TD Asset Management, about the prospects of investing in oil and gas vs. energy producers as the energy transition progresses.
Here to give us some perspective on what's going right now is Hussein Allidina. He is Head of Commodities at TD Asset Management. Hussein, it's great to have you here. Thanks so much for joining us. Before we get into individual commodities, I wonder if we could just back up, and tell me the overall thesis of what is going on here.
- Yeah, sure, Kim. Thanks for having me. I think there's a couple of factors at play. There's a short-term, sort of more cyclical, particularly in the case of the UK and Europe, where they started the winter-- pardon me, they started the summer with less inventory than they typically have on hand in storage. That inventory has not been rebuilt, partially because flows and production in the region have been contained. That's economics and ESG.
And now, we're heading into-- we're weeks away from the winter. Inventories are remarkably tight. You don't have flows coming from Russia. LNG has been competed away, to an extent, to Asia. And the market is, frankly, moving higher to ration demand. And it's quite difficult to ration power demand.
- --I was just going to say some of the commentary that I've also heard is that-- and you alluded to this-- is that the ESG move, we're seeing less funds going into capex, getting fossil fuels out of the ground, which just means there's less supply, and to your point, the demand is still there.
- Yeah, it's really-- like, there's the short-term issue that we're dealing with right now. The sort of more medium-term concern, which might become a shorter-term concern as we kind of move into the winter, is the fact that you have not, for the better part of, say, 10 years, have not had the economic incentive as a producer to go and look for oil, gas, and similar commodities. And now, it's being exacerbated by the fact that the ESG movement, though important, is really focused on the supply side. So we're curtailing the supply. You mentioned coal when we started. Coal prices are at all-time highs. Coal demand is not at all-time highs. Coal supply, however, is falling faster than demand. And that's what's creating this price appreciation and the need for demand rationing.
Similar situation is playing out in natural gas. And Kim, my sort of bigger, broader concern is that this story could play out in energy over the course of the next couple of years, as well. And the impact that that ultimately has on the economy is far more detrimental than power prices in Europe alone. Not to discount what's happening in Europe-- it's significant, it's material-- but energy, crude specifically, is so much more important to the global economy.
- I want to spend some time really getting into the longer-term implications, but before I get there, I just want to take a look at each commodity. Let's start with gas. You mentioned what's happening in Europe, power demand. Those gas prices, nat gas prices are through the roof. Could you see the same thing happening in North America, in the United States?
- Yeah, so today, actually, is timely. Gas closed at a 12-year high today. We're up, I think, 9%, 10%. And what the market is doing is looking at the level of inventory that we have in the US, which is tighter than what we had this time last year, partially a symptom of reduced production, but inventories are reasonably comfortable. They're not remarkably tight.
But what the market is worried about, and I think we saw it in the price action today, is if we end up getting colder than normal weather, there is a scenario where US inventories end below 800, 700 BCF at the end of the summer. And those are critically low levels. So I think what you're seeing is the market rallying to close the export arb. For LNG, we export in the US about 10 BCF a day out of a market that's 90 BCF a day.
And if you run into a scenario where things are super cold, European prices are trading $30 in MMBtu, and that compares to US prices, which are $6 in MMBtu. So you'll have to see US prices move materially higher to close that arb, if needed. If we start the winter milder than normal or average, I think some of this premium that you're seeing in the US, at least in the short term, comes out. Longer term, I think we have more pronounced issues on the supply side.
- I want to get through oil, and I wouldn't mind touching on uranium, too. Oil, same question. I mean, what do you see happening right now? I mean, I've heard calls for triple-digit oil, and some even going higher, and even the move for some power generators to move out of, let's say, natural gas and into oil. I know that's not a quick switch to try and do something about the cost of the input. What do you see happening there?
HUSSEIN ALLIDINA: A couple of things, right? So you're exactly right, there is some incremental demand that we'll likely pick up over the course of the winter as you have substitution in power generation away from gas, which, frankly, is not available in parts of Asia or Europe. You'll see substitution into residual fuel oil, potentially diesel. You're seeing some substitution on the refinery side, as well, where refiners who historically use gas as a feedstock are looking for alternatives. So that's supporting the oil market.
OPEC's decision yesterday to not increase production by more than they had said they were going to do earlier this year I think provided a bit of support, as well. And we have lost barrels and MMBtus in the Gulf of Mexico following the hurricane there late in the summer. And so all those factors, together with still pretty robust demand, I think is contributing to tightening and supporting oil prices.
The other piece, Kim, people are looking at, market participants are looking at what's happening in coal, what's happening in gas, and I think are starting to potentially foreshadow what could happen in crude because the stories aren't dissimilar, right? Lack of investment, lack of supply. We still use a lot of this stuff to drive GDP. And you mentioned it, right, the supply is inelastic. You're not going to get a price response-- even if ESG didn't exist, you're not going to get a price response overnight. Sorry, supply response overnight.
- It's just an incredible confluence of factors all coming together. I've only got about 30 seconds in this piece here, Hussein, but uranium also catching a bid, getting quite a move, actually, the past little while. Is this just, again, the same story in a slightly different tone?
- Very similar, right? You've had economics that have discouraged the investment on the supply side on the upstream for uranium production. And at the same time, when you sit down and you look at the data and you look at some of the targets that we have for 2030, 2040, I don't think you can get to those emission targets without an increase in nuclear generation capacity. And I think that is becoming slightly more consensus, and part of the reason why you're seeing the performance in uranium that you have of late.
- Hussein, the one thing I was curious about, I mean, we're seeing a graph that is going higher, it looks like, for all these energy sources. I know I was speaking with someone before who talked about it's going to be tough for energy companies to really capitalize this on like they have in the past because of all the restrictions around regulatory side, ESG, and maybe even hedging. They will not get the full benefit of seeing these prices go up. What are your thoughts on that?
- Yeah, it's a very good question and a good point. I think that if you look at the price performance of crude, as an example, relative to the XLE or the XOP ETFs that track, you'll see that the equities have underperformed. And I think that, notwithstanding the fact that higher crude prices will be constructive for energy equities or commodity currencies, I don't know that we're going to get the same performance or the same beta that we would have historically. And I think it's for the very reason you mentioned, Kim.
There is an underappreciation or an inability, frankly, of investors, whether it's on the public or private side, to invest in these spaces because of the ESG movement. And I think, ultimately, that makes the commodity all the more constructive because the transmission mechanism between the price and production I think is distorted on the margin because of ESG. That means less supply for any given oil price, which actually leaves me more constructive the underlying commodity.
- It's so interesting. It's a bit of a vicious circle to understand where it's going. I'm curious, so this sounds like this could turn into a prolonged commodity bull market. Is that what you see?
- Yeah, I think the difference or the concern that I have around kind of the durability or the sustainability of this, this is very much a supply-driven issue, a supply-driven challenge, which is different than the sort of supercycle that we saw in the 2000s. That was very much a demand, EM-led demand story. So long as demand remains stout, reasonably stout, I think that you will see continued support and upside in commodity prices.
What I start to worry about, and we're not at the levels yet, but oil as a percentage of GDP, when it gets to 7%, 8% of GDP-- we're probably around 5% right now-- historically, growth has faltered. So the difference, Kim, relative to kind of the 2000s is that this is more of a supply-driven event, which is arguably more similar to what we saw in '73, '74 around the Arab oil embargo or the late '70s when Iran-Iraq had their war, the start of their war, which disrupted supply. And frankly, the implications on growth, inflation are very different if it's a supply constraint issue that is supporting commodity price.
- And maybe just take us through how is it different. If it is supply shock and inflation, I mean, where does that go? What's the impact overall?
- So the piece that concerns me is supply-driven inflation, supply constraints that push up inflation I think lend to more talk, more concerns surrounding stagflation. I'm sure you've seen the number of instances where kind of the word stagflation has come up in research or in conversation. And it's just not as good for growth, right? If you have higher oil prices because there's more demand, that's more sustainable. Higher oil prices because of constrained supply will eventually choke growth.
- But does not, I guess, constrained supply begets a substitution effect, where, I mean, I guess which is the entire hope of ESG, is that you start turning to alternative energy sources. So I guess is that one thing that could change the trajectory, or are we just still too far out for that to actually really take hold?
- No, look, consumers respond and higher input prices, higher commodity prices will force a substitution, not dissimilar from what we saw when oil was last above $100 a barrel. If we look at car sales in the US, as an example, people stopped buying SUVs and pickup trucks, and moved to smaller vehicles. Definitely higher oil prices, I think, will incent and herald at a quicker speed the substitution to renewables.
The piece that I think we're missing here in this conversation broadly, though, is that the transition isn't going to be simple, and it's going to be painful. And Europeans are seeing that today, and will continue to see that in their energy bills. And I think that we just need to do a better job of socializing the fact that it's not going to be easy.
- Hm. Can I ask you, I mean, you talked a bit about energy companies not getting the same beta they would see, I think, with our commodities. But when you think about how this will reflect or show up for Canadian energy producers, or even the currency, the loonie, what do you see?
- I think it's constructive. I think it's constructive. Higher oil prices are definitely constructive for the energy companies. Again, the uptick that they get may not be, probably will not be as comparable to what we've seen in prior cycles because of the change on the ESG front. But higher oil prices is supportive for Canada's terms of trade. It's supportive, by extension, for the dollar. So I think you will continue to see commodity currencies generally, Canada in particular, performing. I'm just not sure that, on the equity side, the performance will be as similar to what it has been historically.
- It's been a fascinating discussion, and we look forward to talking again, Hussein. Thanks so much.
- It's always a pleasure. Thanks, Kim.