FidelityConnects: Geopolitics and growth part two: Canada-U.S. energy and resources

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Welcome back to Fidelity Connects. I'm Glen Davidson.

 

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From oil to natural gas our next guests will break down the key movers in the

 

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energy sector and what they could mean for client portfolios.

 

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I'm joined by portfolio manager, Joe Overdivest, and equity research analyst,

 

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Jin Hwang. Joe manages several Fidelity funds including Global Natural

 

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Resources and Jin covers the Canadian energy sector.

 

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Great to see you both, wonderful to have you here.

 

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Thank you for having us.

 

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I think we'd be remiss if we didn't talk about how you as an analyst and

 

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you, Joe, as a portfolio manager deal with news as it accelerates

 

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like we've seen over the last several days.

 

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Jin, maybe I'll start with you. How did you react when you saw what was going

 

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on with the news in general and energy?

 

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Certainly a busy weekend.

 

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The first thing, funny enough, is actually just turning off the news, taking a

 

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step back and understanding what this actually means.

 

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Our training is specifically in understanding equities and what's priced into

 

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equities so turn off the new, refresh your models, understand what

 

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type of oil environment are these equities pricing in today and being able to

 

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action against that. Once you have a good understanding of the starting point

 

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from there you can start analyzing all the different developments.

 

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For me personally, I have my own work that I kind of do in the background but

 

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just as equally we have a ton of analysts around the world.

 

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This is not just a conflict in energy, it's actually kind of wider reaching.

 

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We have tanker analysts out in Asia, we have different kind of chemicals

 

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analysts out in Europe, speaking to them and understanding exactly what the

 

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implications are across the supply chain and bringing that into the analysis

 

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and bringing it into the work that I did prior.

 

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You've got a lot of great partners around the world.

 

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I like what you said, turn the news off and then figure out what does it really

 

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mean from a quantitative research, from a fundamental research standpoint and

 

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stick with the models that you've created as well.

 

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Joe, you've got experience as an analyst in the past and also many years as

 

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a portfolio manager. How does your day change?

 

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I know you're both very busy anyway but how does it change when things like

 

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this go on?

 

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Saturday morning at 06:00 a.m. the priority is to read, to read about this.

 

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My normal reading would have been was definitely prioritize for the more recent

 

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events.

 

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Obviously, we read the public news but, as you said, having a rock star analyst

 

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like Jin but more importantly, multiplying Jin to a thousand investment

 

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professionals around the world, hearing what people are saying globally in

 

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Fidelity about this event, and more importantly, putting it in perspective.

 

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I've lived through, sadly, certain events like this before but also

 

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others have as well, what is the precedent?

 

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Is there anything we can look towards as like what more importantly for our

 

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clients will happen going forward? That event has already happened, where are

 

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the opportunities? So using all the analysts, a lot of Team's messages, a

 

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lot of calls, a lot of talking with PMs and analysts.

 

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I like that as well because it's not just the analysts you're talking to.

 

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We have this big team. PMs look at different angles, growth, value,

 

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sometimes just sector specialists, really, rewarding as someone who loves

 

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research and loves being very intellectually stimulating at a very dynamic

 

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time.

 

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Jin, Joe called you a rock star analyst.

 

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I can just picture because ... just to paint a picture for our viewers you all

 

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sit in an open concept environment.

 

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You must have had the lineup like you're the next best coffee shop in town.

 

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Everybody's saying, I gotta talk to the energy guy in particular in an

 

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environment like this but there's just a free flow of information.

 

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I'm incredibly fortunate because before me there was another energy analyst,

 

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before that there was another energy analyst, going all the way back to kind of

 

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Joe's days covering the sector specifically.

 

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To Joe's point around understanding historical precedents on these types of

 

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events, I'm able to call up the analyst that was dealing with the US invasion

 

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of Iraq, or even the Russian invasion of Ukraine, to understand how do these

 

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equities actually trade. That positioned us that much better than any other

 

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investment firm because we have that institutional knowledge all kept inhouse

 

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and I can leverage that as the current analyst.

 

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You'll always remember these days, Jin.

 

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100%.

 

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Let's talk about, from your perspective, why is it always, it seems it's always

 

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about oil. What are the ramifications for the market right now based on what

 

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we know?

 

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The conflict can kind of be divided into two pieces.

 

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The first that everyone is really focused on is the Strait of Hormuz which

 

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transports 20% of global oil shipments every day.

 

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The other piece is the broader conflict which could be kind of longer in

 

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duration than we think but everyone for now is focused on that first piece.

 

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The reason that everyone's so focused on this is, look, the energy markets

 

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globally, they're balanced on a knives edge, plus or minus 1% of supply and

 

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demand can actually mean the difference between $50 versus $80 oil.

 

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As we think about the two components, the Strait of Hormuz, I think most

 

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incentives are there for kind of oil to keep flowing, whether it's

 

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the US needing kind of lower oil prices or Iran needing, effectively, oil

 

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export revenue to fund the war, that, I think, most people are generally

 

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confident in. The bigger piece is what happens with the broader conflict and

 

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how long that can go on.

 

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As we sit here today we try to understand what type of oil price environment

 

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are we in, what are the equities pricing in, are they effectively pricing in

 

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those two that we're looking at right now.

 

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Some may ask if the Strait of Hormuz is being backed

 

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up, and it's an insurance issue now, isn't it, we'll see what happens with

 

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that, but when that gets going again the majority of flows, from

 

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my understanding, go to Asia.

 

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In Canada we might be sitting here very soon seeing a huge increase at the

 

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pumps. Can you remind everybody why it affects us the way it does when that

 

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supply really is going elsewhere?

 

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It's an open global market, it's a commodity business so if there is a higher

 

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bidder for that barrel of crude elsewhere, be it Asia, Europe, or the Middle

 

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East even, the commodity is always going to flow there.

 

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While we may be insulated as a net exporter of energy

 

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globally is how most of these things are settled.

 

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Makes sense. Joe, could you give us your perspective on what's happening in the

 

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Middle East and ramifications on Canada?

 

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I think the bigger picture here is it's a very sad, obviously, human element

 

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what's going on but the bigger thing is the geopolitics of this.

 

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Almost sadly we see now two instances

 

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of this going on, very recently Venezuela and, obviously,

 

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this current situation with Iran is, the US isn't even mincing

 

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words in some cases with Venezuela saying we're going to control the oil

 

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afterward. This is very clearly quoted as saying that.

 

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The biggest buyer of much of this oil is China.

 

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Trust me, I'm sure China is very much involved looking at this going,

 

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hmm, this will be interesting our negotiations now because, again, we can get

 

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into this but on the resource side China for a number of years, as we know here

 

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as Canadians, actually bought some of our oil companies back in the early

 

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2000s. Oil was the big driver there of

 

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all of a sudden buying different resources, in particular copper and oil, but

 

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then all of a sudden last few years they've really cornered the market on

 

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critical minerals.

 

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It's probably one of those things, potentially, we'll see how history goes,

 

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they couldn't corner oil but they can corner other markets, and you can see in

 

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negotiations with the US in particular, it's like, well, if you want to put

 

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tariffs on us we're going to cut the critical minerals.

 

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Now you're seeing the US play another chess piece going, well, maybe we have

 

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cornered where you get your cheaper barrels of oil.

 

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This is yet to play out totally but you can see this is big ramifications

 

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for trade and global GDP.

 

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I want to pick up on Venezuela. That seems like a year ago and it really

 

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wasn't. What's interesting is that oil prices came up when the

 

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Venezuela situation happened but not incredibly.

 

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Then there was a bit of a pullback and now what we're seeing is a big increase

 

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in oil yesterday, as we do this today oil's now getting cheaper.

 

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Can you talk about why the prices haven't been, perhaps, as excited

 

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as what the news would allow us to believe.

 

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As you said, tune that out, but I'm curious on your takes as well.

 

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Venezuela was a different situation.

 

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Venezuela was a change in regime and of, course,

 

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what happened pretty much afterward was the military ...

 

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usually with regime changes the military is very important how this gets handed

 

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off. The military and a new leader stepped in and everything moved forward

 

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and, more importantly. the flow of the oil kept going.

 

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What's different right now is, as Jin is saying, as we stand here today the

 

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flow of oil has massively changed, not just for what's coming out of Iran,

 

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what's coming out of the whole Middle East because that one strait there is a

 

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choke point.

 

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That's the difference right now. The biggest thing going forward in the more

 

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short term is can that strait be resolved, otherwise

 

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you're going to be backing up oil into the Middle East.

 

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Let's talk about models that you may have, Jin, in that respect.

 

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What would a three to four week blockade ...

 

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I'm not asking for a specific number ...

 

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but what would that potentially mean to a barrel of oil?

 

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I's interesting. We're balancing two conflicting forces right now.

 

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Heading into this conflict I think the broader consensus was we are

 

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oversupplied oil for at least the near term basis.

 

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With this conflict you've seen oil prices shoot up $15.

 

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What that premium is actually reflecting is exactly what you're alluding to,

 

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it's actually a couple of weeks of disruption.

 

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To the extent that the Strait of Hormuz, and everyone's bet that the Strait of

 

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Hormuz remains open kind of starts to fade and becomes more like a month or two

 

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months you're going to start seeing that premium start to increase pretty

 

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quickly.

 

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The challenge right now is the market's taking over a one-directional bet that

 

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it's going to remain open and you're seeing that not just in kind of the

 

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immediate price is not jumping as much as you think but even further back on

 

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the curve, kind of 12 months out, the bets on oil prices 6 or 12 months up,

 

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they actually still remain fairly depressed and that's a one-directional bet

 

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that the Straits can remain open. Opportunities like that are where we're

 

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trying to make sure we're not offside and making sure that we have the right

 

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bets in place to not only kind of make money in the short term but also cover

 

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those tail scenarios where let's say the Strait does remain closed for two

 

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months, what does that mean for these equities?

 

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I like that. You're looking at the core opportunities but you're looking at the

 

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tails as well.

 

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Hello, investors. We'll be back to the show in just a moment.

 

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DialoguesFidelity podcasts available on Apple, Spotify, YouTube, or wherever

 

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else you get your podcasts. Now back to today's show.

 

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Joe, let's go back to you just on a little bit of politics.

 

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Does the power and influence and importance of oil overwhelm

 

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politics?

 

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In certain parts of history you would say yes.

 

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You would you say, well, why does it even matter?

 

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We look at different commodities, you talk about steel

 

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or copper gets talked about a lot about, they're small percentages of

 

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world GDP. Oil or energy, natural gas, just include energy altogether,

 

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it's probably mid-single digits of global GDP.

 

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More importantly, indirect costs are probably multiple times

 

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that. When you buy food at the grocery store there's energy that was used to

 

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bring that there, to actually farm it.

 

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When you buy products there's chemicals, there's plastics in it.

 

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There's many multiples of that mid-single digits that are affecting

 

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our lives and inflecting economies.

 

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What happens generally, no one cares about oil, all of a sudden oil prices

 

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start going up. The average person says I'm doing more at the gas pump than I

 

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used to do in terms of price and all of a sudden everything I'm buying is going

 

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a little higher. I'm upset, my standard of living is going down, this is

 

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not good. Guess what happens?

 

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They get upset, politicians all of sudden go, well, if all of sudden people are

 

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upset guess what happened? They say who are we going to get mad at?

 

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Politicians are going to vote us out. Then they go, well, okay, that's where it

 

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comes now political, just geopolitical, because we need to solve this.

 

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We need to say, okay, what countries can we partner with to get cheaper energy.

 

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Yes, it definitely has an effect.

 

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Again, what we're seeing here is if you want to actually have a leverage point

 

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as well that's probably one of the best ways to leverage something is energy

 

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because it's like the backbone of much of our daily lives.

 

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Jim, let's direct our conversation to our fair country of Canada.

 

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What's surprising you about energy today?

 

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I think it's just how much the sector's actually changed over the last couple

 

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of years. For some context, prior to me covering energy I

 

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actually had a negative bias against the space because we know all the boom and

 

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bust cycles.

 

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Full disclosure here, eh?

 

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If you take a step back 10 years ago it was driven by these balance sheets

 

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being terrible, cost structures being inflated, pipelines being constantly

 

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full. Fast forward to today and all that's completely 180.

 

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You have balance sheets that are pristine, you have cost structures that

 

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support free cash flow generation all the way down to $40 oil, you have

 

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pipelines that are now in abundance, and all of a sudden these are now free

 

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cashflow machines. It's really the directional change of the sector relative to

 

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my original thinking. What's interesting is I don't think most people are there

 

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yet in understanding that level of change.

 

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Everything you're hearing about me on Canada specifically right now is

 

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diametrically opposed to everything you are hearing elsewhere.

 

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We hear about US shale, that was the abundant player for the last couple of

 

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years, that's starting to slow. You're hearing about OPEC, maybe

 

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[indecipherable] is a little less.

 

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Canada is really well positioned with our third largest reserves in the world

 

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to potentially be kind of the next beast within energy for the next 10 years.

 

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There was a story today in the paper, well, online, that's

 

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how old I am, about US shale production actually not stepping in.

 

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Why would that be?

 

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Typically, with these things you drill your best type of resource first and

 

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after 10 years of the shale boom where production was growing 500,000, a

 

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million barrels a day all of a sudden you start to run out of inventory.

 

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If you look at the US landscape in total, years of inventory

 

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left, somewhere in the 8 to 10 years level. You look at Canada,

 

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we're looking at north of 50 potentially. It's more just slow down

 

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because they've already drilled a lot of their best stuff and now they just

 

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want to preserve what they have, versus Canada, we have kind of untapped

 

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resources all throughout sort of Western Canada.

 

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There is a big difference between those two right now.

 

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Thank you for that. Joe, AI expectations and demands for

 

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energy. Can you talk about that?

 

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AI is definitely one of the biggest drivers of many things, copper but also

 

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energy. We talk to the actual tech companies and the utility companies in many

 

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ways, they'll say in the short term it's probably more natural gas will solve

 

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it just because it's the quickest energy source you can bring on to power the

 

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electricity, but longer term will be nuclear which, again, Canada sits very

 

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well in terms of providing the actual uranium but also developing

 

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some of these nuclear reactors.

 

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Is that like small modular reactors, SMRs?

 

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It'll be a combination of everything.

 

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We actually had a few conferences recently where government officials spoke.

 

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We had an energy conference in Miami, we had another one in Florida recently on

 

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metals. It's amazing too how things have changed geopolitically, the keynote of

 

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both events was US government officials.

 

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How they would say it in terms of safety,

 

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I guess, of nuclear is they're looking more at who's doing it.

 

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When they look at who they want to invest with, number one is is it tight

 

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supply-demand? Number two is can they get it here in the US?

 

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Number three, though, more importantly, they're looking at who's the pinch

 

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point in the supply chain. If someone else can corner the market on something

 

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they're more likely to invest or actually partner with them.

 

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Let's talk about uranium and copper, just keeping with the nuclear but also

 

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from a metal standpoint.

 

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When we look at copper, in particular, it's probably one of the tightest supply

 

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and demand right now. I would say oil is probably a little further out  but

 

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it's getting there. The reason why copper is so much is actually in terms of

 

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reshoring, electrification, obviously, AI is more front-end loaded what's

 

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going on. Nuclear, definitely we see a deficit

 

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that you're seeing right now, there's not a big change.

 

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There's not many major projects coming on for uranium for the next few years

 

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and if so, they're usually in kind of maybe riskier countries or they're

 

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involving major permits. Until those permits come all bets are off.

 

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Right now uranium and copper are probably some of the tightest in terms of

 

[00:15:27.927]

supply and demand of the commodity outlook overall.

 

[00:15:30.229]

Can I just ask you a quick tangent on gold?

 

[00:15:32.765]

I look at you, I think of gold, I'm not sure why, I know you have an opinion,

 

[00:15:36.068]

and you also have great access. Could you talk a little bit about that?

 

[00:15:40.072]

The joke is I was supposed to be at one of the biggest gold company CEO's

 

[00:15:43.242]

offices right now but, again, that's the beauty of Fidelity, even when we're

 

[00:15:46.178]

busy we sent our gold analyst who will report back to me.

 

[00:15:49.448]

So you could be with us. This is wonderful.

 

[00:15:50.482]

Could be with us, exactly.

 

[00:15:53.152]

When you look at different commodities it's all about supply and demand.

 

[00:15:55.654]

Gold is a very unique asset and gold is more built on it's a reserve currency.

 

[00:16:00.359]

Really, what drives it is interest rates, inflation, more

 

[00:16:04.730]

importantly, your view on the US dollar and other major currencies.

 

[00:16:07.566]

What's changed after the Ukraine crisis is major central banks around the world

 

[00:16:11.670]

are moving away from the US dollar and buying gold.

 

[00:16:14.340]

That's a major buyer. We talk about ETFs, central bankers will dwarf all

 

[00:16:18.510]

that, and they have dwarfed it.

 

[00:16:20.713]

The biggest question for investors and for us is, really, do

 

[00:16:24.850]

you see going forward central banks continuing to favour less

 

[00:16:29.621]

US dollars in their investments and more towards gold.

 

[00:16:33.392]

If that continues that's what drives gold to where it is.

 

[00:16:37.229]

Again, it's not like, oh, it's supply and demand or it's the marginal cost,

 

[00:16:40.165]

it's just not like it when it comes to oil or copper.

 

[00:16:42.901]

Thank you for the gold tangent. Let's go back to energy.

 

[00:16:45.237]

Jin, I wanted to ask you about where the Liberals stand on oil and gas today.

 

[00:16:48.941]

It's interesting. I think for the first time in 10 plus years we're seeing a

 

[00:16:51.710]

little more bipartisan support towards energy development within this country.

 

[00:16:54.780]

I think that's been spurred by kind of the productivity crisis we've been for

 

[00:16:58.150]

that period. Energy is just a natural place and offset for that because

 

[00:17:02.221]

we're solving sort of two things here.

 

[00:17:04.390]

One is just we, obviously, need productivity to improve in this country and we

 

[00:17:07.359]

are in doubt with massive energy reserves all throughout the country.

 

[00:17:10.729]

The second is, and I think Iran sort of accelerated this, there is

 

[00:17:14.767]

an increasing focus on energy security, I think, globally.

 

[00:17:17.770]

We may be looking at 20% of global oil suddenly disappearing overnight

 

[00:17:22.207]

and countries are going to look for alternative sources of supply pretty

 

[00:17:24.743]

quickly. Canada with the third largest reserves globally fits that bill pretty

 

[00:17:28.180]

quickly. We have the need to export and countries have the need import.

 

[00:17:31.984]

With the layer of a productivity crisis I think there's a little more support.

 

[00:17:35.454]

We've heard kind of about the new pipeline opportunities out there.

 

[00:17:38.857]

Even putting that aside a lot of the companies in the ground have already

 

[00:17:41.460]

worked through a lot of different ways to improve pipeline capacity even beyond

 

[00:17:44.563]

a brand new pipeline.

 

[00:17:46.765]

Looks good and generally I think we're headed in a more positive direction.

 

[00:17:50.636]

We've just had a question come in and, Joe, I'll go to you because it's about

 

[00:17:54.073]

copper. It just says about the impact of fibre expansion on copper.

 

[00:17:58.944]

I think it all drives copper in many ways.

 

[00:18:02.915]

At this point in time it's a small part of it.

 

[00:18:05.551]

Probably the biggest thing still is the data centres but all are driving the

 

[00:18:08.987]

same kind of connectivity of the world and more data coming.

 

[00:18:11.490]

I think also too the sovereignty of it.

 

[00:18:13.859]

One of the biggest things when you talk to actually the companies who are

 

[00:18:16.962]

talking to the governments, one of biggest sensitivities is where will the data

 

[00:18:20.933]

be? That's being asked more and more.

 

[00:18:23.001]

That's why, in particular, for our Canadian government we almost want to be

 

[00:18:27.072]

involved with the discussion about data centres because if we don't

 

[00:18:31.110]

solve it and provide the energy here we'll be sending our data across

 

[00:18:35.214]

borders and it will actually usually sit in the US.

 

[00:18:38.083]

That's a bigger issue that maybe will drive certain decisions, in particular to

 

[00:18:42.154]

providing natural gas, uranium for our own data centres.

 

[00:18:45.190]

Great. I'm sure that was very useful for our viewer.

 

[00:18:47.693]

Let's go back to the energy cycle. What signals are you watching right now to

 

[00:18:51.163]

kind of figure where we're at?

 

[00:18:52.698]

My whole job is understanding supply demands.

 

[00:18:55.934]

We know demand is generally headed for a higher direction.

 

[00:18:58.137]

We used to think oil demand would plateau sometime in the 2030s, that's being

 

[00:19:01.573]

reshaped entirely. Now we think we don't really see an end until well beyond

 

[00:19:05.344]

2050. Against that, we've been lucky for the last 10, 15 years where we

 

[00:19:09.448]

always knew where the next barrel of supply was going to come from.

 

[00:19:11.850]

The US shale environment was growing consistently, OPEC was continuing to grow,

 

[00:19:14.853]

we had some offshore developments that were starting up.

 

[00:19:17.156]

The next 10 years is actually not that clear.

 

[00:19:19.558]

What we're trying to understand is we're trying to skate to where the puck's

 

[00:19:21.593]

going. In this case we know that there's not going to be that much net new

 

[00:19:24.730]

supply. Canada has a ton of it, do we see a bridge from point A to point B on

 

[00:19:28.700]

that basis.

 

[00:19:29.902]

It's interesting talking about energy because it's a real diversifier and yet

 

[00:19:33.105]

there's tangential connections to AI so it does take people

 

[00:19:37.242]

away from where their core portfolio may be, and then there's also some

 

[00:19:40.712]

connections. Can you maybe, as we sort of summarize,

 

[00:19:44.950]

what are key opportunities that we, as investors, should think about from an

 

[00:19:48.487]

energy standpoint?

 

[00:19:50.088]

The overarching theme here is we don't know where the commodity price is

 

[00:19:52.758]

ultimately going to be any given day but we do know that Western Canada is

 

[00:19:55.661]

going to grow its energy production pretty significantly.

 

[00:19:58.197]

We're about to potentially triple our LNG export capacity over the next decade

 

[00:20:01.433]

plus. We have visibility to new pipeline expansions that potentially increase

 

[00:20:05.137]

exports by up to 50% if all goes through.

 

[00:20:08.774]

Who's going to benefit from that? It's producers drilling the molecules from

 

[00:20:11.643]

the ground, the service companies that are facilitating that, the pipelines

 

[00:20:14.279]

that are getting it to market. It really is across the value chain and it still

 

[00:20:18.016]

feels early in this investment cycle that I'm really excited about.

 

[00:20:20.686]

Okay, good, I'm glad you're excited about it. Joe, let's talk about where the

 

[00:20:24.523]

role of energy and natural resources are within a diversified portfolio.

 

[00:20:28.894]

I think natural resources provide, obviously, an inflation protection, usually

 

[00:20:32.998]

a diversification, especially with the major markets around the world right now

 

[00:20:35.901]

are very tech-heavy.

 

[00:20:38.570]

Lastly, it does involve some geopolitics.

 

[00:20:40.806]

We've already alluded to many times being

 

[00:20:44.843]

gold, oil in particular, are sometimes offsets

 

[00:20:48.981]

to some kind of unforeseen events, as, obviously, the last few even months

 

[00:20:52.951]

have seen. I think that gives you some balance into your portfolio.

 

[00:20:57.789]

Makes sense. Joe, Jin, thanks so much for being here.

 

[00:21:00.692]

That was a rapid fire session, lots that we covered, and I'm glad you were able

 

[00:21:04.696]

to really connect it to what's going on geopolitically right now.

 

[00:21:07.432]

Thanks to you both for being there.

 

[00:21:10.102]

Thank you for tuning in as well.

 

[00:21:11.637]

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