Nurit Altman:
Welcome to The Real Pulse. I'm your host, Nurit Altman. 2021 marked a stark reversal of fortunes in the energy sector, with improving supply demand fundamentals, more resilient business models, and robust oil prices bolstering energy companies and setting the stage for continued growth. Many believe these are only these early stages of a constructive energy cycle. One of those believers is Michael Tran, Managing Director, Global Energy Strategy and Digital Intelligence Strategy at RBC, who joins us to share his views on where oil prices will go in 2022 and the implications for the Alberta market. Mike, thank you for joining today.
Michael Tran:
Pleasure to be here. Thanks for having me, Nurit.
Nurit Altman:
Mike, oil prices are up 50% over last year, and throughout the past year, you have been saying that these are still early days of a constructive oil market cycle. Do you still hold that view? And can you share your thoughts on that outlook?
Michael Tran:
Look, this is a great question. So clients have heard me say time and time again over the past 12 months that we are in this early stage of a very constructive oil market cycle. I said it a year ago and I continue to use those same words now. And when you think about, well, what's a client's reaction to that statement? Naturally, many of them will say to me, "Well, Mike, look, oil prices have rallied 50% in the past year. Surely, we must be further along in the cycle?" Now, I think the most important thing that I've learned over the course of the past year is that, when considering oil market cycles, many investors actually conflate and confuse price with duration, i.e. oil prices have rallied 50% in the past year, like you said. So we surely should be further along in the cycle, but I don't actually think that we are. I still think we're in the early innings.
Michael Tran:
Now, what I think is really important is, when you ask the average investor, what drives oil prices? Many of them will, of course, say, "Well, supply and demand." I think that's only about half true. Look, if you study oil market history, most oil market cycles are either supply led or demand led, but they're rarely led by both at the same time. Usually, there's a dominant force that leads while the other one takes a backseat. I think this year is going to be just one of those unique years, and if we're even directionally right about this, this is going to be the first time in a decade when we'll see demand strength leading alongside supply side tightness as the co-pilot. This is what's becoming increasingly clear and visible to the market and this is what I think makes this cycle really unique. You have both supply and demand [inaudible 00:02:43] bullish at the same time.
Michael Tran:
Some people will call this a super cycle. I can't disagree with that comment. I think the bottom line is, what's most important is the shape and the size of the cycle that drive the near and medium term investment proposition. And I think the market is learning over recent quarters that the area under the curve of the current oil cycle is expanding, not shrinking, and so is the investment proposition. And we're talking about this over the next several years. We're not talking about the end of the decade.
Nurit Altman:
A year ago, you highlighted the three step process to structurally higher oil prices. For those listening who haven't heard about this process, can we revisit it and can you share how the process has evolved over the past year?
Michael Tran:
For those who follow our work, you'll be tired of hearing me just continue to hammer away at this theme over the course of the past year, year to half. We have really stayed loyal to this three step process towards, how do you get to structurally stronger oil prices? Here's how it breaks down. Number one, you get rid of the iceberg of the storage, that backlog that we built up during the early days of COVID. When we were stuck in our house, we couldn't drive, we couldn't fly, there was a massive amount of oil demand destruction. We've been running that storage level down towards historically normal levels now. Number two is, you run down OPEC's spare capacity from the historical high seen during the initial wave of COVID. So, in essence, we've been working through these first two steps over the course of the past 18 months. It's a methodical process and it's going well.
Michael Tran:
Now, the next upside trigger is something that we've been anticipating that is something that's likely to play out closer to the end of this year. And that's the third point, the call on U.S. shale rises. Now, this is the SOS signal to the market that after a decade of U.S. production growth spoiling, torpedoing, virtually every single oil market rally, we'll get to the point later this year where we've exhausted other options and the market calls on U.S. shale to grow to prevent the market from over heating. Now, we've been saying this for over a year now, but let's be clear, this, the call on U.S. shale, is arguably the most bullish catalyst that I can think of. So these three steps moving in sequential order, I think this is really what's providing the framework or the blueprint of a structurally stronger oil market.
Nurit Altman:
So everything I've heard so far is bullish, and I like bullish. But as we sit here today, Russia has troops lined up on the border of Ukraine and we are all still waiting for the endemic stage of COVID and the grand reopening of the world. So my question to you is, how bullish can we be and how much higher could we go? Is $100 per barrel of oil potentially in scope this year?
Michael Tran:
Everything that we have talked about is bullish. It's hard to be anything but. Look, we're recording this in early January. We've had two weeks since the holidays, and I think what's really important is, I've actually challenged our sales people to say, "Find me an oil market bear to talk to because every client I've talked to so far this year is bullish." It's actually hard to find anybody who is negative on this market. If there are bears out there, they're certainly in hibernation mode. Now, as you mentioned, everything we've talked about so far is quite bullish. Oil fundamentals are strong, like we've discussed. I think number two is, when you think about one of the major themes in global markets this year, it's inflation. Owning commodities, owning energy is an inflation hedge. That's back in vogue now. We're getting a lot of questions about this. This is undoubted going to be a major theme.
Michael Tran:
Now, commodities as an inflation hedge has been out of fashion for the past decade, and now we're seeing more and more capital pour into asset managers' AUM in this space now. The third point I think is geopolitics. Your comment about Russian and truth lined up at the border of Ukraine, you're seeing supply side outages on the oil side in various different parts of the world as well to start the year. Libya, Gabon, Kazakhstan, there's no shortage of supply side outages here. So there's an additional geopolitical risk premium that's pricing back into the market to couple with inflation and also the strong oil market backdrop. So when you think about these three ideas, the directional arrows of progress all serve as tailwinds for prices that continue and in our view will likely remain quite strong. It certainly would not be surprising to see prices challenge that $100 mark at some point this year.
Nurit Altman:
Well, this all sounds like good news for those listening who own property in Alberta. But now that you've shared your bullish outlook, can you walk us through some of the risks to your view?
Michael Tran:
Look, no conversation would be complete without talking about where I could potentially be wrong. So I think it's really important to really just touch on the interconnectedness of macro markets so that we have a holistic view of the risk framework. Now, we know that inflation is, like I mentioned, returning back into the idea of commodities as an inflation hedge. That playbook, like I mentioned, hasn't really been relevant for quite some time. That's creeping back into conversations now. When you think about ideas that are tangential to the inflation idea, how should we think about the strong dollar, et cetera? Now, if you consider the relationship between WTI and the Dollar Index, look, how often over the past 20 years has the Dollar Index traded at '96 like it is now and WTI prices have held at $80 or $85 where we're currently trading at? The short answer is 0% of the time.
Michael Tran:
We're actually in uncharted territory right now from a historical relationship standpoint, and we've been here for, call it, much of the past three months, six months last year with historical frameworks being challenged. Now, I'm not saying that a strong Dollar Index cannot coexist with strong oil prices. It's just that we haven't seen this historically for quite some time. So I do think that it's really important to consider the lens at which macro risk allocators may also be watching the interconnectedness of these markets. Now, that aside, I'll also highlight energy policy as potentially being a downside risk for oil prices. Look, we try to quantify as much as we can. We try to run scenario analysis around our base case views to understand the risk asymmetry in the market.
Michael Tran:
Now, the hardest corners of the market are the qualitative drivers, the policy shifts, particularly by governments. And heading into a U.S. Midterm cycle this fall, the Biden administration knows that inflation, higher gasoline prices, higher prices to heat homes is a huge negative for the average American consumer and they'll carry that negative sentiment into the ballot box. So whether this is policy that entails releasing more barrels from strategic reserves as a government or pulling on other levers, I really believe that the U.S. government will be looking to provide some reprieve to U.S. consumers at the pump in the form of lower oil prices.
Nurit Altman:
Mike, with what sounds like steadfast belief in structurally higher oil prices, what do you see as the implications for the Alberta market? When do you expect that we will see higher oil prices translate into increased capital spending and ultimately more Calgary office jobs to fill empty towers?
Michael Tran:
Calgary is near and dear to my heart. My wife is from there. My parents, my sisters, and their families live there and work in the oil patch. It certainly hasn't been the easiest ride for Calgarians over recent years given the volatility of oil prices all the way from $100 oil a decade ago to negative oil pricing that we saw last year. I will say that, over the near term, the fundamental oil framework is really the strongest setup in over a decade. When I talk to local clients, we're certainly feeling a degree of buzz return back into the city, which is really, really encouraging. Companies are doing really well now from a cash flow perspective. I do believe that this cycle for the oil market will be strong for several years and this should translate into a very vibrant community in Calgary and Alberta again.
Michael Tran:
And whether that equates to an expansion of personnel back into some of these, to your point, empty office towers, I think maybe that remains a little bit to be seen from my seat. But I'm certainly very hopeful. I will also say it's really nice to see the increased focus on diversifying the industry, particularly from a growing tech startup scene as well. So when we have this conversation perhaps a few years from now, I'm hopeful that when we talk about this very strong oil market cycle that we're seeing now, we're going to see Calgary continue to flourish over the course of the next several years and maybe even have different industries to lean on outside of just the oil and gas space as well.
Nurit Altman:
Well, I'm hopeful as well, and I think your positive outlook will be a welcomed view amongst many listening today. So Mike, thank you for joining us.
Michael Tran:
Thanks again for having me, Nurit. Quite the pleasure.
Nurit Altman:
I'm Nurit Altman, and this is The Real Pulse.