Recession seems inevitable

How badly will energy stocks fare?

The indicators all point to a recession starting by year end 2023. One notable indicator is the level of optimism about a “soft landing” which seems to peak just before the downturn begins based on this Bloomberg chart from a great article by Anna Wong and Tom Orlik published today.

The same Bloomberg article notes that interest rates and energy costs peaked on the eve of recession in the past.

And, Bloomberg’s article points out that for most Americans, their COVID support-fueled savings have about run out.

In my opinion, the issue is not whether there will be recession but rather when it will start and when will it end? My bet is the recession is already underway and will become evident in the data released in Q1 2024 which always lag the event itself. The auto strike isn’t helping any, higher diesel prices are pushing inflation higher and household budgets are squeezed already. The incessant debate in Washington over funding the government is a distraction, but the level of spending is unsustainably high and as spending falls, so will economic activity.

For energy investors, the question is how badly will a recession pummel oil & gas prices and for how long will they crater? I expect a sharp contraction over the next few months with WTI falling as low as US$60 a barrel, a long way down from the US$90 range of recent days but a level where industry cash flows remain positive. Natural gas prices will be impacted by weather - a warm winter will compel softer prices than a cold one - and it is a mugs game to forecast weather. I expect natural gas in North America to remain at or above current prices through at least February simply because seasonal demand, warm or cold winter, will push prices up in the absence of more supply and expanded LNG production in both U.S. and Canada will keep the market tight regardless of the temperature. But by spring, prudence suggests investors expect prices to fall into the head and shoulders season.

Does it matter? Not that much really. Canadian E&P companies are doing just fine today, have robust balance sheets and are disciplined (perhaps for the first time in decades) in capital spending and will not “drill drill drill” even if prices rise for a few weeks. I see a recession as a buying opportunity possibly at very low share prices driven by cash flow multiple contraction (investors always over react to negative news, it seems) and will add to my already solid portfolio of both oil & gas weighted producers who pay regular dividends. A recession will last a few quarters (if history is any guide) and recovery will follow, perhaps a bit more briskly than usual since it is a Presidential election year and Biden will throw money at the electorate in a desperate attempt to buy enough votes to garner a second term, likely in vain since no one wants to see him in the White House geriatric ward for another four years, based on recent polls.

Expect volatility, keep a healthy cash balance, and build a portfolio of dividend paying companies with clean balance sheets and low operating costs. Joining the “buyback” parade is likely to box your ears as share prices fall and someone else is cashed out while you wait patiently for the promised higher share price the buyback is supposed to compel, getting the odd margin call as a punishment for irrational exuberance and being forced to sell into a soft market.

Companies poised to benefit are those who saw the value in shedding debt and can weather a recession readily - names like Birchcliff Energy (BIR.TO), Tourmaline (TOU.TO), Bonterra Energy (BNE.TO), and, Whitecap (WCP.TO). You can use their dividends (except Bonterra who has yet to resume dividends) to add to positions at discounted prices, even if the dividend rate is lowered to protect balance sheets.