Where to find energy opportunities

Despite continued weakness, the energy and materials sectors still offer opportunities.

“We favour energy because of [its] fast-cycled nature and because demand has historically grown every year; the only time demand didn’t grow was in 2008 and that was as a result of the financial crisis,” says Scott Vali, formerly vice-president of equity for CIBC Asset Management.

Read: Canadian oil production will continue to grow: report

Energy is fast-cycled, he adds, because “when investment stops, production reacts very quickly and starts to decline. That’s different than a lot of the other commodities we look at, particularly in the bulk commodity areas like coke and coal and iron ore. When projects come on [in those spaces], they tend to last for multiple years at very robust production levels.”

Take iron ore and coal projects such as the building of railways and loading terminals, says Vali. “Once built, they add large incremental capacity to the market. For example, when you build railways and ports, it’s usually for large additional volume. This volume then lasts for 20 to 30 years and has low cash operating costs.”

But, if demand for iron ore and coal products “declines during the period when large incremental supply is entering the market, the price of [those] products would decline and returns would be weak.”

In contrast, says Vali, “Incremental oil capacity is usually small (oil sands would be an exception) and starts to decline fairly quickly, requiring continued investment to maintain production. Without investment, production falls off relatively quickly, which should lead to an increase in the price of oil. The market is more likely to balance itself more quickly, given the declining nature of the production.”

Read: Commodities could strengthen in 2016, says expert

Currently, Vali has more than 60% of his fund invested in the energy space. Along with keeping an eye on companies’ balance sheets and gathering insights from fixed-income experts, he examines whether the companies he’s invested in have the “ability to work through this lower-commodity environment and come out the other side stronger and in a better position to increase their earnings.”

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Vali and his team have also increased the cash portion of the fund so they can take advantage of trends and opportunities. “Over the past little while, as markets have sold off, we’ve been adding to some of our positions.”

One Canadian energy company that Vali favours is Canadian Natural Resources, which is investing throughout this down cycle.

Read: 4 priorities for Canada’s energy sector

In the U.S., he’s focused on companies like EOG Resources and Pioneer Natural Resources. Both “have tremendous asset bases that continue to grow and show improvement,” largely due to advancements in technology.

On the materials side, Vali is looking at U.S. speciality chemicals companies, including Sherwin-Williams, PPG and Ecolab. These are consumer-facing companies, says Vali. And, “U.S. consumers continue to be fairly strong. So those companies will benefit as their sales are directly to that consumer.”

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In particular, “Ecolab is a name that, longer-term, has a structural advantage with respect to water purification. This is a thematic we think will play over a long period of time, as water becomes a greater focus for investors [and] for citizens around the world.”

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