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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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

15:27.927 --> 15:30.229
supply and demand of the commodity outlook overall.

15:30.229 --> 15:32.765
Can I just ask you a quick tangent on gold?

15:32.765 --> 15:36.068
I look at you, I think of gold, I'm not sure why, I know you have an opinion,

15:36.068 --> 15:40.072
and you also have great access. Could you talk a little bit about that?

15:40.072 --> 15:43.242
The joke is I was supposed to be at one of the biggest gold company CEO's

15:43.242 --> 15:46.178
offices right now but, again, that's the beauty of Fidelity, even when we're

15:46.178 --> 15:49.448
busy we sent our gold analyst who will report back to me.

15:49.448 --> 15:50.482
So you could be with us. This is wonderful.

15:50.482 --> 15:53.152
Could be with us, exactly.

15:53.152 --> 15:55.654
When you look at different commodities it's all about supply and demand.

15:55.654 --> 16:00.359
Gold is a very unique asset and gold is more built on it's a reserve currency.

16:00.359 --> 16:04.730
Really, what drives it is interest rates, inflation, more

16:04.730 --> 16:07.566
importantly, your view on the US dollar and other major currencies.

16:07.566 --> 16:11.670
What's changed after the Ukraine crisis is major central banks around the world

16:11.670 --> 16:14.340
are moving away from the US dollar and buying gold.

16:14.340 --> 16:18.510
That's a major buyer. We talk about ETFs, central bankers will dwarf all

16:18.510 --> 16:20.713
that, and they have dwarfed it.

16:20.713 --> 16:24.850
The biggest question for investors and for us is, really, do

16:24.850 --> 16:29.621
you see going forward central banks continuing to favour less

16:29.621 --> 16:33.392
US dollars in their investments and more towards gold.

16:33.392 --> 16:37.229
If that continues that's what drives gold to where it is.

16:37.229 --> 16:40.165
Again, it's not like, oh, it's supply and demand or it's the marginal cost,

16:40.165 --> 16:42.901
it's just not like it when it comes to oil or copper.

16:42.901 --> 16:45.237
Thank you for the gold tangent. Let's go back to energy.

16:45.237 --> 16:48.941
Jin, I wanted to ask you about where the Liberals stand on oil and gas today.

16:48.941 --> 16:51.710
It's interesting. I think for the first time in 10 plus years we're seeing a

16:51.710 --> 16:54.780
little more bipartisan support towards energy development within this country.

16:54.780 --> 16:58.150
I think that's been spurred by kind of the productivity crisis we've been for

16:58.150 --> 17:02.221
that period. Energy is just a natural place and offset for that because

17:02.221 --> 17:04.390
we're solving sort of two things here.

17:04.390 --> 17:07.359
One is just we, obviously, need productivity to improve in this country and we

17:07.359 --> 17:10.729
are in doubt with massive energy reserves all throughout the country.

17:10.729 --> 17:14.767
The second is, and I think Iran sort of accelerated this, there is

17:14.767 --> 17:17.770
an increasing focus on energy security, I think, globally.

17:17.770 --> 17:22.207
We may be looking at 20% of global oil suddenly disappearing overnight

17:22.207 --> 17:24.743
and countries are going to look for alternative sources of supply pretty

17:24.743 --> 17:28.180
quickly. Canada with the third largest reserves globally fits that bill pretty

17:28.180 --> 17:31.984
quickly. We have the need to export and countries have the need import.

17:31.984 --> 17:35.454
With the layer of a productivity crisis I think there's a little more support.

17:35.454 --> 17:38.857
We've heard kind of about the new pipeline opportunities out there.

17:38.857 --> 17:41.460
Even putting that aside a lot of the companies in the ground have already

17:41.460 --> 17:44.563
worked through a lot of different ways to improve pipeline capacity even beyond

17:44.563 --> 17:46.765
a brand new pipeline.

17:46.765 --> 17:50.636
Looks good and generally I think we're headed in a more positive direction.

17:50.636 --> 17:54.073
We've just had a question come in and, Joe, I'll go to you because it's about

17:54.073 --> 17:58.944
copper. It just says about the impact of fibre expansion on copper.

17:58.944 --> 18:02.915
I think it all drives copper in many ways.

18:02.915 --> 18:05.551
At this point in time it's a small part of it.

18:05.551 --> 18:08.987
Probably the biggest thing still is the data centres but all are driving the

18:08.987 --> 18:11.490
same kind of connectivity of the world and more data coming.

18:11.490 --> 18:13.859
I think also too the sovereignty of it.

18:13.859 --> 18:16.962
One of the biggest things when you talk to actually the companies who are

18:16.962 --> 18:20.933
talking to the governments, one of biggest sensitivities is where will the data

18:20.933 --> 18:23.001
be? That's being asked more and more.

18:23.001 --> 18:27.072
That's why, in particular, for our Canadian government we almost want to be

18:27.072 --> 18:31.110
involved with the discussion about data centres because if we don't

18:31.110 --> 18:35.214
solve it and provide the energy here we'll be sending our data across

18:35.214 --> 18:38.050
borders and it will actually usually sit in the US.

18:38.083 --> 18:42.154
That's a bigger issue that maybe will drive certain decisions, in particular to

18:42.154 --> 18:45.190
providing natural gas, uranium for our own data centres.

18:45.190 --> 18:47.693
Great. I'm sure that was very useful for our viewer.

18:47.693 --> 18:51.163
Let's go back to the energy cycle. What signals are you watching right now to

18:51.163 --> 18:52.698
kind of figure where we're at?

18:52.698 --> 18:55.934
My whole job is understanding supply demands.

18:55.934 --> 18:58.137
We know demand is generally headed for a higher direction.

18:58.137 --> 19:01.573
We used to think oil demand would plateau sometime in the 2030s, that's being

19:01.573 --> 19:05.344
reshaped entirely. Now we think we don't really see an end until well beyond

19:05.344 --> 19:09.448
2050. Against that, we've been lucky for the last 10, 15 years where we

19:09.448 --> 19:11.850
always knew where the next barrel of supply was going to come from.

19:11.850 --> 19:14.853
The US shale environment was growing consistently, OPEC was continuing to grow,

19:14.853 --> 19:17.156
we had some offshore developments that were starting up.

19:17.156 --> 19:19.558
The next 10 years is actually not that clear.

19:19.558 --> 19:21.593
What we're trying to understand is we're trying to skate to where the puck's

19:21.593 --> 19:24.730
going. In this case we know that there's not going to be that much net new

19:24.730 --> 19:28.700
supply. Canada has a ton of it, do we see a bridge from point A to point B on

19:28.700 --> 19:29.902
that basis.

19:29.902 --> 19:33.105
It's interesting talking about energy because it's a real diversifier and yet

19:33.105 --> 19:37.242
there's tangential connections to AI so it does take people

19:37.242 --> 19:40.712
away from where their core portfolio may be, and then there's also some

19:40.712 --> 19:44.950
connections. Can you maybe, as we sort of summarize,

19:44.950 --> 19:48.487
what are key opportunities that we, as investors, should think about from an

19:48.487 --> 19:50.088
energy standpoint?

19:50.088 --> 19:52.758
The overarching theme here is we don't know where the commodity price is

19:52.758 --> 19:55.661
ultimately going to be any given day but we do know that Western Canada is

19:55.661 --> 19:58.197
going to grow its energy production pretty significantly.

19:58.197 --> 20:01.433
We're about to potentially triple our LNG export capacity over the next decade

20:01.433 --> 20:05.137
plus. We have visibility to new pipeline expansions that potentially increase

20:05.137 --> 20:08.774
exports by up to 50% if all goes through.

20:08.774 --> 20:11.643
Who's going to benefit from that? It's producers drilling the molecules from

20:11.643 --> 20:14.279
the ground, the service companies that are facilitating that, the pipelines

20:14.279 --> 20:18.016
that are getting it to market. It really is across the value chain and it still

20:18.016 --> 20:20.686
feels early in this investment cycle that I'm really excited about.

20:20.686 --> 20:24.523
Okay, good, I'm glad you're excited about it. Joe, let's talk about where the

20:24.523 --> 20:28.894
role of energy and natural resources are within a diversified portfolio.

20:28.894 --> 20:32.998
I think natural resources provide, obviously, an inflation protection, usually

20:32.998 --> 20:35.901
a diversification, especially with the major markets around the world right now

20:35.901 --> 20:38.570
are very tech-heavy.

20:38.570 --> 20:40.806
Lastly, it does involve some geopolitics.

20:40.806 --> 20:44.843
We've already alluded to many times being

20:44.843 --> 20:48.981
gold, oil in particular, are sometimes offsets

20:48.981 --> 20:52.951
to some kind of unforeseen events, as, obviously, the last few even months

20:52.951 --> 20:57.789
have seen. I think that gives you some balance into your portfolio.

20:57.789 --> 21:00.692
Makes sense. Joe, Jin, thanks so much for being here.

21:00.692 --> 21:04.696
That was a rapid fire session, lots that we covered, and I'm glad you were able

21:04.696 --> 21:07.432
to really connect it to what's going on geopolitically right now.

21:07.432 --> 21:10.102
Thanks to you both for being there.

21:10.102 --> 21:11.637
Thank you for tuning in as well.

21:11.637 --> 21:15.574
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