What the opening of Trans Mountain could mean for Canada’s energy sector

Well, the price of oil is down some 8% from the high it hit earlier in the year as concerns about a wider conflict in the Middle East have subsided. But with risks on both the supply and demand side, where does the price of oil go from here? And what does it mean for the energy sector? Joining us now to discuss is Andriy Yastreb, vice president for portfolio research at TD Asset Management. And, Andriy, thanks for joining us today, and we'll start with the price of oil. Is this $70-to-$90 trading range for oil the new normal? Well, thank you for having me. And to answer it directly, I think, yes, it's probably the range we will continue to see in the future. And we've seen it for about a year and a half already. I think it's also a range that is sustainable because it satisfies both suppliers and customers. So we've seen last year and so far this year pretty robust demand growth, so obviously $90 oil is not-- is not resulting in some declines in demand. From supplier perspective, it's pretty much all about OPEC. And if you think about OPEC, I don't think OPEC wants $100-plus oil. Their reaction function is not to maximize price of oil. It is to have it high enough that they will satisfy their own internal needs like balancing their budgets for Saudis, UAE, and a lot of other producers. But at the same time, they don't want to incentivize adoption of EVs and people switching away from gasoline cars. And they don't want to incentivize increasing CapEx and production growth in the US and other countries that they compete with. So that $70, $80, $90 price range satisfies all of those. And I think-- as we think over the next several months, it will be interesting to see how OPEC and Saudis in particular think about potentially bringing back that million barrels that they did a voluntary cut last summer because if we see oil being in the lower end of that range, maybe they extend it, and it's positive. But if we see oil again rebounding to 90, I think it's high probability that a million barrels a day would come back to the market. And from that perspective, I don't think there's too much upside in the oil price from here. And from your perspective, that isn't necessarily a bad thing for oil companies. How does this pricing environment set things up for oil companies generally? So that's an interesting point because usually when investors think about investing in oil companies, they want oil prices to go 20%, 30%, 50% higher. You want to work to commodity I think it has changed since COVID. We've seen a couple of really strong years of returns. But from here, it's not as much about oil going higher significantly. It's more about the fact that all of these energy companies have very clean balance sheets. They have very high free cash flow yields. And because they don't grow and they don't need to invest in CapEx as much as they used to, they can return most of that cash, right? So when we are talking about those free cash flow yields for large integrated producers, those can be in 7%, 8% range. For a lot of smaller producers, that's 10% and above, right? So from that perspective, having that confidence that they will be returning that cash back, if you stay within that range, that's sustainable over time, and that's really good return through dividends and buybacks. And you don't have that much risk of them going out and investing in CapEx. Historically, their cycle was, OK, oil price is high. Let's go and drill more, invest more. And then oil prices crashed. Let's pull some of that back. I think we are a lot more disciplined now, and I think it's a lot more healthier environment for investors to make money over time and compound those earnings. OK, let's talk a little bit about the Canadian market. When you look at the Canadian energy sector versus the US, how do they differ right now? So that's another very good question. One key-- key catalyst that we've been waiting for years is happening, and actually it's happened literally today on May 1. TMX expansion is officially operational as of this morning, and it's doing-- taking commercial crude and shipping it. And soon it will be filling tankers. We've been waiting for this for years. Yeah, this is a big deal for the Canadian energy sector. Yes. So what it means is that we will have over half a million barrels of extra capacity to ship more products out of Canada, which is great. It means that Canadian producers can grow. Before they were constrained by pipeline capacity, and now it will be easier to invest in growth over time. And secondly, it means that the pricing that the Canadian producers will be getting will be more sustainable over time. We've seen periods in the past where production was way above capacity to ship. And at those times, Canadian oil was trading at a significant discount because it was hard to get oil out of the basin. So now, as we get into this new regime for the next few years until this pipeline is also full, we have a capacity. We have opportunity to grow, and we probably have better prices as well. And how long will it take, do you think, for that capacity to-- I think the estimate is about anywhere between two to five years. I think two years is probably too aggressive, looking at where the capital discipline is right now with these companies. I don't think they will feel it necessarily within two years. Five years is probably too long. I think three, four years is more-- more prudent estimate. A second factor that you need to keep in mind for Canadian energy versus US energy is that Canadian energy actually benefits from weaker Canadian dollar. And we've seen US dollar going up year to date across pretty much all major currencies, and then we've seen also weakness in Canadian dollar after we've seen what's happening with Canadian budget and some weak economic data here in Canada. So if this weakness continues, that will be actually a big tailwind for Canadian producers. If we look at Canadian oil being priced today in Canadian dollars, for Western Canadian select, it's mid $90 in Canadian dollars. And for synthetic crude oil, it's over $110 per barrel. So pretty good pricing for Canadian-- Canadian oil right now. OK, now I want to pivot from oil to natural gas. How's this environment looking for this commodity? So natural gas is an interesting story because obviously you don't have an OPEC control in this market. And what we've seen in this market recently or last six months, nine months, natural gas pretty much got destroyed. So spot natural gas prices in US is over-- just under $2 per-- per cubic feet. And what that means is that we've just seen really weak demand, and a lot of the driver behind that was we've seen two really warm winters in a row. And inventories are elevated. On top of that, this winter we've seen warm winter not only in North America but in Europe. So on both sides of Atlantic, we have a situation where inventories are elevated at the end of heating season. Production is still quite robust, and there is a risk that we'll get to tank tops in terms of inventories by September or October, at which point you cannot produce more because you cannot store natural gas. So if you want, we can bring up a chart-- Yeah, I think we brought that chart up earlier. Let's bring it up once more. ANDRIY YASTREB: And what this is showing is two things. One is, the green line shows today's forward curve for natural gas, and forward curve is basically price of natural gas in futures market. So you can trade natural gas for delivery next month, six months from now, or '26-- 2026, '28. So we've seen this weakness that I was talking about as that green line is below orange and gray line, which is where the curve was 6 and 12 months ago. But I think what's really interesting is that the later part of that line in 2026 and through 2028. Those prices haven't really changed. And that's I think where it becomes really interesting for natural gas because the view of two to three to four years out is that we know that in response to weak prices right now some production has been reduced, especially in the US. So we had peak in production earlier this year around 106 BCF per day. Now we are under hundred. But then the other part of that is that we know that there's more LNG export capacity coming over the next several years. We have LNG Canada ramping up later this year here in Canada. We have also several facilities coming online in the US. And what that means is that we know there is going to be more demand at the time when-- and those elevated inventories will not last forever. So what the market is telling you right now is that spot net gas prices under $2. Some marginal producers don't make money in that environment if they sell in spot. But that 2026 through '28 price is still $4, and that expectation was there pretty much the same level about a year ago. So if market is correct and we go from under $2 to $4, I think that will be beneficial to net gas prices and the companies involved.