CA - OPEC+ Cuts Production. Will Canada's Energy Sector Benefit?

2023-04-05 21:30:00 ET

Summary

• Are energy and financials at a crossroads?
• What OPEC+ cuts mean for Canadian energy players.
• The banking crisis may not be over, but Canadian banks remain robust.

The production cut from OPEC+ could have implications for Canada’s energy industry. Greg Bonnell speaks with Michael O’Brien, Portfolio Manager at TD Asset Management, about OPEC’s move and what it could mean for the energy market in Canada.

Transcript

Greg Bonnell: We appear to be at a potential crossroads for the two biggest sectors on the TSX. Investors, of course, are weighing the impact of the OPEC+ production cuts on the energy sector and all these continued concerns about the health of the banking sector. Joining us now to discuss where things may go from here, Michael O'Brien, portfolio manager at TD Asset Management. Michael, great to have you back on the show.

Michael O’Brien: Yeah, thanks. Thanks for having me.

Greg Bonnell: So these are the two big ones on the TSX. Obviously, no shortage of big global headlines around them. Don't know where to start. Let's start with energy. Energy seems to be the latest one, with OPEC's big surprise on the weekend. What has this done for the TSX energy sector in terms of where we thought it might be this year?

Michael O’Brien: Well, I think if you looked at what was happening to energy for the last month and a half, two months, up until the OPEC announcement, really, the narrative had been captured by concerns around the economic outlook. So it was a much darker, much more bearish narrative, a lot of people focusing on if there is a recession, how much demand destruction. And then the weak oil price kind of made people just think that this was definitely where we were heading.

I think the OPEC announcement, which caught people a bit by surprise, it basically reminded investors that this is a two-way street. People were getting a little too carried away with all the bad things that could happen. What investors kind of forgot, and the Saudis reminded us in no uncertain terms, is there's somebody looking out for this market. OPEC, I think, communicated in no uncertain terms that they don't want to see oil prices with a 7 in front of it or a 6 in front of it. They put their money where their mouth is. They're going to defend these prices.

And that shifts the conversation or the debate into a much more balanced one now. Obviously, concerns about the economy haven't gone away. Concerns about potential impacts on demand haven't gone away. It's just we're now reminded that the supply side of the equation is quite constrained, and the leading players are going to do their part to make sure that oil prices don't fall out of bed completely.

When you bring this back to the stocks, we're sitting here today, oil's in the $80 range. And when you think about light-heavy differentials in western Canada have improved a lot-- they spent most of the winter between $25 and $30 discounts, today they're $14, $15. With that kind of a backdrop, these companies are very profitable. Despite all the negativity, despite all the concerns around the economic and macro headlines, we're left with a basket of stocks that is still very, very profitable and will be returning a lot of cash to shareholders one way or another this year.

Greg Bonnell: So energy has its own thesis to trade off of now. Because up to, I guess, the weekend and the surprise production cut, it was-- the concerns that were weighing on the financial sector seemed to be weighing on energy as well. Have we shaken off-- I mean, I was showing a US regional bank to the audience to start off with, and they seem to be a bit under pressure. Have we moved past that story, or are there lingering concerns?

Michael O’Brien: I think what you're seeing today is there are lingering concerns. JPMorgan's CEO Jamie Dimon, who's kind of viewed as the elder statesman for the American banking industry, his letter to shareholders today, his prediction was that we're not done. There'll still be some bumps in the road as we go through this. If you think back to the financial crisis, it seemed to come in waves. So I think we'd be remiss not to expect a few flare-ups as we go forward.

That said, I do feel that the authorities, the central banks, the regulators, move pretty quickly in this situation. Things do seem to be stabilizing in terms of at least the data investors can see around deposit flows and what the bank lending facilities are being drawn on in the US. They would indicate that things aren't back to normal. There are still some pressures out there. But at least those worst fears seem to have been headed off. This idea of cascading bank runs does not seem to be happening. Deposit flows are stabilizing.

So I would say we're not out of the woods, but clearly we're in a better place than we were two or three weeks ago, which is what we would have hoped, in other words, that you can contain this, that one or two banks that mismanaged their balance sheet aren't going to infect the whole system.

Greg Bonnell: Yeah, one of the words I was hearing often was that, whether it was Silicon Valley Bank ( SIVBQ ) or Signature ( SBNY ) or the others, was "idiosyncratic," that these banks sort of organized their affairs in a way that wasn't the most prudent way, and that other banks weren't going to fall to the same-- into the same trap, really.

Michael O’Brien: Yep. And anybody who lived through the financial crisis of 2008-2009, we all learned the hard way to be careful when you say something is idiosyncratic. Because what often appears to be idiosyncratic, it turns out to be not so unique after all.

Greg Bonnell: And maybe other people were up to the same thing, yeah.

Michael O’Brien: Exactly. And so in this case, again, I think we're in a good place here. And when you do go back and do the autopsy, so to speak, on Silicon Valley Bank and what went wrong, I mean, there are some glaring mistakes that they made. And it is a unique franchise where it was far too concentrated with a specific customer base, venture capital. Their deposit base wasn't diversified. Their assets and liabilities were mismatched. There were some glaring mistakes there. And it is a very idiosyncratic situation.

However, some of, I guess what I would say the root cause of what forced this on Silicon Valley Bank, which is a rapid rate hike cycle, that is not unique to Silicon Valley Bank. And some of the pressures that we saw that impacted a number of US regional banks very hard, to a greater or lesser extent, you can find those same impacts across many of the banks.

And one of the areas specifically that people are looking at right now and investors are-- with a very microscopic attention to detail is these assets on their balance sheet. So in other words, you took in a deposit, and you invested it in, say, a 5-year US Treasury or a 10-year US Treasury back when interest rates were at 1% or 2%. That wasn't unique to Silicon Valley Bank. They did more of it. It was more egregious. It was less well-managed. But to a greater or lesser extent, you're going to see that in a lot of the other banks.

And so that's where it really becomes important, as an investor, is to try to differentiate between the situation Silicon Valley Bank found itself in and the other banks that you want to own, you want to invest in, or you do invest in. And so we'll flow this into the Canadian Bank discussion--

Greg Bonnell: I wanted to ask you about that, right?

Michael O’Brien: --for sure.

Greg Bonnell: --because we're talking Silicon Valley Bank. We're talking US financials.

Michael O’Brien: I think there are some very good--

Greg Bonnell: Then we might talk Credit Suisse, and we're talking about the other side of the world. But back here at home, our financials did feel some downward pressure because of all this.

Michael O’Brien: Absolutely. And again, the root cause of all these issues is a very rapid rate hike cycle, both in the Bank of Canada and the US Federal Reserve. That creates pressure on the system. But then when it comes to, OK, how do we differentiate? How do we separate the banks that are in real trouble versus the banks that are going to be more resilient? I mean, I could go down a long list in terms of why the Canadian banks are different. But I think the most basic and simple difference is if you look at the nature of our deposit base for the big five, the big six banks, very diverse, very sticky deposit bases. Whereas Silicon Valley Bank, the root of the issue there was you had massive depositor flight, and basically the vast majority of Silicon Valley's deposit base was venture capital investors and tech startup companies that were burning cash rapidly and needed their money back.

If you look at, whether it's TD Bank, Royal Bank, Bank of Montreal, the sources and the diversity of the funding sources that we have to run our banks here in Canada, far more stable. And so everything that I've been hearing to date, you're not seeing the same type of disruptive drawdown of deposits in the Canadian banking system.

And at the end of the day, if you don't have that pressure on the deposit base, there's no reason to worry about some of these other problems that Silicon Valley Bank had with held to maturity, securities portfolios that were underwater. If you don't have the deposit pressure, you can hold those. It's not an issue.

So I think, at least what we've seen so far, "idiosyncratic" a dangerous word, but when you sort of flow it and compare it to the Canadian situation, I think the Canadian banks are in far better shape in terms of that liquidity pressure.

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