The energy market has done a reasonable job of shifting demand amid the strain of increased oil reserve consumption, says Michael Shaw, director and portfolio manager on the Canadian small cap strategy at Franklin Templeton’s ClearBridge Investments.
The U.S. and Israel’s ongoing war on Iran, which started at the end of February, has resulted in limited supply lanes through the Strait of Hormuz, which normally sees the flow of nearly a fifth of the world’s supply of oil.
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While several analysts have stated June 1 is the latest possible date for a resolution before the global impact becomes critical, Shaw notes the oil market has extended that deadline a few times already.
Whenever an agreement is finally reached, he says the global energy system will launch a normalization process by first getting tankers moving regularly, with current estimates at around 200 days. The next phase will include the infrastructure rebuilding process across the Middle East and finally, the system will need to rebuild the inventory consumed through the crisis.
The implications for Canadian energy equities can be very different, he says. “They embed commodity prices over a longer period of time [and] their capital allocation decisions are different than the objectives of Middle Eastern governments or the Trump government.”
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Last year, Canadian energy equities performed well in the face of increased inventory and declining prices, which he sees as surprising since it’s rare to see the price of a commodity decline while the energy equities outperformed. He says it’s indicative of the improving quality of these businesses following difficult years during the coronavirus pandemic.
“If we roll the clock back to [before the coronavirus pandemic] these were very capital intensive business models. . . . In the subsequent six years, they’ve become very good operators and very good capital allocators.”
He says shareholder payout has become the non-moveable wedge of the capital allocation strategy for these businesses as capital discipline in the space becomes the standard. According to a note from ClearBridge, the small-cap energy sector was up 34.8 per cent by the end of March.
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