Viking

Here is the latest from Eric Nuttall - the bull case for holding energy stocks. What appeals to me the most about energy is how profitable oil companies are at even $$70-80 oil. Energy stocks look like they are discounting $60 oil (or lower). My guess is OPEC will cut production if oil gets close to $70. Russia also does not want low oil prices. My read is there is a floor price for oil that is high enough that energy producers will continue to make very good money. And the oil market is tight enough that OPEC/Russia will be able to manage the price to where they want it (even if we get a recession in Europe /US next year). My guess is OPEC/Russia does not want the oil price to fall much below $80. ————— Ninepoint Energy Fund Marketview- September 26, 2022 - https://www.ninepoint.com/commentary/commentaries/2022/092022/energy-fund-market-view-september-26/ “While the drawdown is nausea inducing and can serve to shake conviction in the absence of data, it is we believe only temporary. We have learned that the best opportunities come when fear is rampant yet fundamentals are strong. That is our assessment of things today. With the SPR ending, China signaling the potential slow return to normal, US shale growth stalling, and OPEC ready to cut production should the oil price sell off, we view valuations today as extremely attractive and potential outsized returns compensating for the additional volatility that the sector carries. With our average holding trading at an estimated 2.5X EV/CF at $80 (1.9X at $100WTI), down 37% from June highs, global oil inventories continuing to draw, and several potentially positive catalysts in the months ahead, we remain bullish.”

Stocks (S&P500) is down about 25%. The 10 year US Treasury now yields about 4% = 20% about bear markets in bonds? The time to be really worried about stock and bond markets was back in January. Now if the global economy goes into recession in 2023 then financial market averages will likely continue to struggle. Lots of good values out there today (especially for investors with a longer term holding period).

My guess is each energy company will approach capital return in slightly different ways. Each establishing a base dividend at a +5% yield looks pretty much in the bag (if they are not already there). 1.) CNQ: it looks to me like they will prioritize special dividends over share buybacks. They recently did a $1.50 special dividend when their share price was lowish. They are reducing net debt but not as aggressively as CVE. 2.) CVE: capital return will be a bit of an open canvas here. The clear focus continues to be net debt reduction. Get the base dividend higher is the first easy decision after net debt target is achieved. My read is management will be very tactical and opportunistic with capital return: if the stock is cheap they will plow it all into that. If stock isn’t cheap they will also do big special dividends. I also think CVE might make some large acquisitions (if they are a great strategic fit and accretive over the medium term) and this might piss people off. Bottom line, i think CVE might be the most unpredictable. 3.) SU: already has a large regular dividend. Priority this year has been stock buybacks (regardless of price), even over paying down debt. So i expect SU to be the least rational of the big players with respect to capital return - they will hold their finger to the wind to sense what they think the market wants them to do and do that. Not a terrible outcome for investors. So if an investor wants a big dividend payout (regular + special) i would go with CNQ. My focus is total return so i am good holding a basket.

i don’t think the Fed knows what they are going to do. Their messaging has completely flipped the past 18 months. And every meeting this year their messaging has changed in important ways. Just look at all the significant changes they just made in their forecasts. The Fed is at the Disney part of tightening financial conditions. It is VERY easy to be a hawk on the Fed right now. Wait until the economic pain gets turned up from the current mild - to medium - to hot. If inflation is still high… the Fed will be screwed. Do we get Burns or Volker? No idea. Because the Fed doesn’t even know right now. But based on past actions, i do not have a lot of confidence they will get it ‘just right’.

I have chosen a basket approach to investing in energy. And living in Canada i stick to Canadian names (lots of good choices outside of Canada as well). My go to are usually the following: 1.) CNQ: the gold standard. Large, growing nat gas exposure. The more i learn about the company the more i like it. If i had to buy one and hold it for 10 years this would be the one. 2.) CVE: the upstart… still digesting Husky. Not sure how good management is… better than Suncor but likely not as good as CNQ. 3.) SU: poorly managed for years… but the stock price reflects that. Has some near term catalysts (asset sales) that should accelerate it getting to net debt target (the decision in Dec on divesting the retail stations will be important). After that, capital return to shareholders will be meaningful. Activist investor Elliott is chewing on its ass… 4.) For mid caps i like MEG, WCP and TVE. Each has a slightly different story. Mid caps, especially MEG, often move +20-30% more than the large caps (both directions) and i like that (for a trade). There are lots of other good choices here.

My portfolio is up nicely this year. It is pretty much all due to two large energy trades. Yesterday i was happy to load up again. The volatility is crazy (driven by sentiment). It is such a bizarre set up (who in their right mind wants to own energy stocks when the global economy is rolling over). It is also pretty clear to me that oil stocks are uninvestable for the majority of investors in the Western world. Where energy investments get really interesting is when companies start hitting their net debt targets. As an example, CVE might hit their net debt target at year end. That is 13 weeks away. The important part is they are very close. Once they have hit their net debt target they will start returning 100% of their free cash flow to investors: regular dividend, stock buybacks and special dividends. At US$80 oil the returns to investors will be significant. Their stock price is at C$20. When they start buying back shares in volume the stock price will increase meaningfully. This will be a company with next to no debt (so minimal interest cost). No exploration risk. Profitable at US$45 oil. In other words, a $20 bill laying on the ground for those willing to pick it up.

Well energy investors were given a gift yesterday. One of many examples: MEG.TO fell from $18 to $14 in a week. Nuts. ————— The Saudi Aramco CEO spoke at recently at the Schlumberger Digital Forum and succinctly laid out the reality of energy markets today. Bottom line, Western governments are in denial; their transition plan “was just a chain of sandcastles that waves of reality have washed away.” Ouch! ————— Remarks by CEO Amin H. Nasser at Schlumberger Digital Forum 2022 - https://www.aramco.com/en/news-media/speeches/2022/remarks-by-amin-h-nasser-at-schlumberger-digital-forum …This week, however, autumn begins, and the global energy crisis promises a colder, harder winter, particularly in Europe. Unfortunately, the response so far betrays a deep misunderstanding of how we got here in the first place, and therefore little hope of ending the crisis anytime soon. So this morning I would like to focus on the real causes as they shine a bright light on a much more credible way forward. When historians reflect on this crisis, they will see that the warning signs in global energy policies were flashing red for almost a decade. Many of us have been insisting for years that if investments in oil and gas continued to fall, global supply growth would lag behind demand, impacting markets, the global economy, and people’s lives. In fact, oil and gas investments crashed by more than 50% between 2014 and last year, from $700 billion to a little over $300 billion. The increases this year are too little, too late, too short-term. Meanwhile, the energy transition plan has been undermined by unrealistic scenarios and flawed assumptions because they have been mistakenly perceived as facts. For example, one scenario led many to assume that major oil use sectors would switch to alternatives almost overnight, and therefore oil demand would never return to pre-Covid levels. In reality, once the global economy started to emerge from lockdowns, oil demand came surging back, and so did gas. By contrast, solar and wind still only account for 10% of global power generation, and less than 2% of global primary energy supply. Even electric vehicles comprise less than 2% of the total vehicle population and now face high electricity prices. Perhaps most damaging of all was the idea that contingency planning could be safely ignored. Because when you shame oil and gas investors, dismantle oil- and coal-fired power plants, fail to diversify energy supplies (especially gas), oppose LNG receiving terminals, and reject nuclear power, your transition plan had better be right. Instead, as this crisis has shown, the plan was just a chain of sandcastles that waves of reality have washed away. And billions around the world now face the energy access and cost of living consequences that are likely to be severe and prolonged. These are the real causes of this state of energy insecurity: under-investment in oil and gas; alternatives not ready; and no back-up plan. But you would not know that from the response so far. For example, the conflict in Ukraine has certainly intensified the effects of the energy crisis, but it is not the root cause. Sadly, even if the conflict stopped today (as we all wish), the crisis would not end. Moreover, freezing or capping energy bills might help consumers in the short-term, but it does not address the real causes and is not the long-term solution. And taxing companies when you want them to increase production is clearly not helpful. Meanwhile, as Europe aggressively promotes alternatives and renewables technologies to reduce one set of dependencies it may simply be replacing them with new ones. As for conventional energy buyers, who expect producers to make huge investments just to satisfy their short-term needs, they should lose those expectations fast. And diverting attention from the real causes by questioning our industry’s morality does nothing to solve the problem. That is why the world must be clear about the real causes and face up to their consequences. For example, as investments in less carbon intensive gas have been ignored, and contingency planning disregarded, global consumption of coal is expected to rise this year to about 8 billion tonnes. This would take it back to the record level of nearly a decade ago. Meanwhile, oil inventories are low, and effective global spare capacity is now about one and a half percent of global demand. Equally concerning is that oil fields around the world are declining on average at about 6% each year, and more than 20% in some older fields last year. At these levels, simply keeping production steady needs a lot of capital in its own right, while increasing capacity requires a lot more. Yet, incredibly, a fear factor is still causing the critical oil and gas investments in large, long-term projects to shrink. And this situation is not being helped by overly short-term demand factors dominating the debate. Even with strong economic headwinds, global oil demand is still fairly healthy today. But when the global economy recovers, we can expect demand to rebound further, eliminating the little spare oil production capacity out there. And by the time the world wakes up to these blind spots, it may be too late to change course. That is why I am seriously concerned….

@Xerxes i appreciate the debate With my comments on Russia i am not inferring anything about past imperialist actions of ‘Western’ nations. I have said numerous times that what the US/West did in Iraq was a catastrophe. The world is an imperfect place.

@Xerxes yes history tends to move in very long and slowly changing arcs. Sometimes it pivots abruptly. All empires end. The Russian/Soviet empire that Putin harkens to is dead. Where is the Austro-Hungarian empire today? Where is the Ottoman empire today? These are two of many examples of empires that lasted for hundreds of years that are no more (well they are still around… just much smaller). Now when empires die they never go quietly into the night. Putin is doing his best to channel Peter the Great. The people in Russia who support Putin are typically old - and they yearn for ‘the good old days’. The geopolitical world that existed 50 or 100 or 200 or 300 years ago no longer exists. Russia is trying to turn back the clock and live in the past. Except the countries on its borders, Europe and the world has moved on. So in trying to return to past glory (and empire) Putin is only accelerating Russia’s decline.

Are we at the beginning of the ‘something breaks’ part of the Fed tightening cycle? Bond yields are on a one way train higher. The US$ is on a one way train higher. What is next? Is this the beginning of the panic trade? Having some cash just might be a really good thing in the coming weeks…

I think it is really not all that complicated to understand what is going on in Ukraine. It is a good old fashioned land grab. An old, tired and failed empire disintegrated about 30 years ago. Pretty much all countries on the periphery (about 15) have been for decades pivoting to Europe and the West and away from Russia. What is the driver? These countries feel being aligned with Europe/the West provides the best opportunity to them and their kids to have a better life. Ukraine was late to pivot away from Russia. Unfortunately for Ukraine, Russia decided it needed more land. Unfortunately for Russia, Ukraine, with the blood of its citizens, has decided to fight. Simply amazing what a taste of freedom does to people. Something we should all remember. ————— Russia wants to turn back the clock. The countries it wants to subjugate disagree. And they are willing to fight. Self determination is a powerful force. Not that complicated.

It looks to me like this war is just getting started. Putin just confirmed this. Off-ramp? Both side think they are winning. So my very uninformed guess is this will be a war that is waged until a victor emerges. And if it is Ukraine, the tail risks stop being tail risks.

@longlake95 I agree. The increase in US Treasury rates, across the curve, continues its upward march: 2022 1 Mth 1 Yr 3 Yr 5 Yr 10 Yr Jan 1 0.05% 0.40% 1.04% 1.37% 1.63% Mar 31 0.17% 1.63% 2.45% 2.42% 2.32% Jun 30 1.28% 2.80% 2.99% 3.01% 2.98% Sep23 2.67% 4.15% 4.21% 3.96% 3.69% This is a big, big win for Fairfax. How much of a win will depend on a couple of factors: 1.) how high do rates ultimately go? 2.) how long do rates stay high? Treasury rates are already higher than I thought possible. But Powell just said rates will be going higher and staying higher well into 2023. Now I don't necessarily believe that is what will happen. Lets hope I continue to be wrong. 3.) does Fairfax increase duration? Not as of June 30 (still at 1.2 years). This will be perhaps the key piece of information I will be looking for when they report Q3 results. If they start to push the average duration out then that will give investors more certainty regarding the future path of interest income. 4.) do credit spreads blow wider? Not yet. But if the economy starts to roll over we likely will get a credit event. The Fed looks like it is going to keep raising rates until something breaks... I wonder if credit markets blowing out (and volatility soaring) will be the trigger for the Fed to stop and eventually reverse course. ---------- There is a short term negative to rising interest rates. And that is the significant market-to-market loss that gets booked at the end of the quarter as the fixed income portfolio gets re-valued: - Quarter 2 = ($445 million) - YTD 2022 = ($1.008 bilion) - small offset: U.S. treasury bond forward contracts gain Q2 = +$32 million and YTD = +$100 million Given the move in rates so far, it loos like the hit in Q3 will again be large: $500 million? Still, rising interest rates is a very good news story for Fairfax in 2 important ways: 1.) much higher interest income earned for years into the future 2.) potential for significant mark-to-market gains should interest rates ever come down again. Especially if Fairfax increases duration at attractive interest rates.

It looks like India will be a big winner as companies shift production from China. Apple doing this is a very big deal. ————— Apple Inc may make one out of four iPhones in India by 2025, JPMorgan analysts said on Wednesday, as the tech giant moves some production away from China, amid mounting geopolitical tensions and strict COVID-19 lockdowns in the country. The brokerage expects Apple to move about 5% of iPhone 14 production from late 2022 to India, which is the world's second-biggest smartphone market after China. It is also estimating about 25% of all Apple products, including Mac, iPad, Apple Watch and AirPods, to be manufactured outside China by 2025 from 5% currently. https://www.business-standard.com/article/international/apple-may-move-a-quarter-of-iphone-production-to-india-by-2025-jpmorgan-122092100786_1.html

What the West is learning the hard way is our quality of life is tied at the hip to cheap energy. The crazy part is much of society in the West is still in the denial stage of this crisis. North America will be a big winner in the near term (we have cheaper energy). Industrial production shifting from Europe. Re-shoring production from China. This will likely be inflationary. Supports higher rates for longer that some guy named Powell was talking about today…

Fairfax India finished Q2 with about $200 million in cash. IIFL Wealth, when it closes, will bring in a little less than $200 million. If sold Fairchem Organics could bring in another +$200 million. $600 million in cash… that is a lot! What to do? Buy something big that will meaningfully grow future BV? Or do a Stelco sized dutch auction (30 million shares) at $13 (crazy low price si it is very accretive)?

My base case is central banks are chicken hawks. The Fed is trying to talk down inflation. Yes, fed funds has been going up but it is still way below core inflation. It is easy to be an inflation ‘hawk’ today in the US because the economy/employment is still solid. If US economy/employment starts to roll over my guess is Fed / global central banks will likely show their true colours and chicken out (become more dovish). But this will stimulate the economy and likely drive inflation higher. Bottom line, we look like we are getting closer to a fork in the road…

@Thrifty3000 For 2022 my guess is interest expense will finish the year around $450 million (adding $10 million for the recent issuance to the current run rate). 2023 = $475 million. This includes lease liabilities. My focus with my estimates/models is 12 and 24 months out. There are so many big moving parts - for me - it is pretty useless to try and go further out than that. Fairfax has little debt maturing the next couple of years (they did a pretty good job refinancing and pushing out some maturities in 2020 and 2021). The future path of interest rates will have a huge impact on Fairfax (to state the obvious). If fed funds goes over 4% late this year and remains over 4% for all of 2023 then Fairfax’s interest income is going to be massive (+$1.4 billion in 2023). They will have ample cash flow to pay off any debt that comes due. Or they might decide to pay a higher interest rate and refinance and push the small amount of 2024 maturing debt further out. But having to refinance a small amount of debt at a higher interest rate is a great problem to have (when you have a $35 billion fixed income portfolio with an average maturity of 1.2 years). ———— From FFH Q2 report: Interest expense in the second quarter and first six months of 2022 of $108.8 and $212.7 (2021 - $117.8 and $283.9) was comprised of interest expense on borrowings of $97.2 and $188.9 (2021 - $101.6 and $252.2, inclusive of a loss on redemptions of holding company unsecured senior notes of nil and $45.7) and interest expense on accretion of lease liabilities of $11.6 and $23.8 (2021 - $16.2 and $31.7). ————— Upcoming debt maturities: 2024 = $283 million 2025 = $277

I think the most likely scenario is Fairfax India continues to buy back shares. When the ICICI Wealth sale happens they will be flush with cash. Fairfax owns a little over 40%. Is there a limit to how high Fairfax’s ownership can go before they are forced/required to take out all the shares of Fairfax India? ————— i was adding to my small position in Fairfax India on Friday at under $10. If Fairfax decided they wanted to take Fairfax India private at $15 i would do a happy dance. I would be happy to take a 35-40% gain (on my average cost) and roll the proceeds into Fairfax (my holding is in a tax free account). ————— Fairfax India is an exceptionally well run business. And it is a broken stock. This happens. The problem for Fairfax India is how does it scale? The rational thing to do today is buy back all the shares they can… the problem is this is shrinking the company. And lack of liquidity is probably one of the biggest reasons the stock is so cheap; buying back stock makes this problem worse. But how does Fairfax India get another $1 or 2 billion to scale? The management team there deserves to have more $ to manage - based on their track record. ————— We KNOW Prem wants to invest significant $ in India in the coming years (i think he said something like $5 billion). Now this will likely include partners (OMERS, CCIB ETC). The question is how does this investment happen? ————— Fairfax India reminds me of Brookfield Property Partners. Brookfield eventually did the obvious - took it private at a big discount.

Interesting interview. First i have heard of Palantir (software company). The interview is a bit of an advertisement for the company. But there are some interesting things discussed. A few take aways: 1.) the economic model of the last 40 years is dead - pretty much impossible to predict what China does moving forward because you have to get inside the head of one man (Xi) 2.) where the globe goes from here (economically and politically) is an open canvas 3.) the US looks well positioned (adaptability; cheap energy)

Can we now reasonably say that the base case is that Fairfax should be able to earn about US$100/share moving forward? With the shares closing today below $500 that is a PE of 5. Using the ‘back of the napkin’ method: With a CR of 95. And with an after tax return of 4% on $50 billion investment portfolio. $750 million + $2 billion = $2.75 billion / 23.7 million shares = $116/share. Bit of a buffer of about $350 million… enough to cover minority interests, loss from runoff, interest expense etc? Looking out another year, if: 1.) the hard market continues (and we get another year of +15% top line growth) 2.) Fairfax is able to push duration of the bond portfolio out to +3 years at attractive yields 3.) Fairfax finds one or two assets to monetize 4.) Fairfax buys back $500 million or another $1 billion in stock Well… $100/share will start to look low as a base case.

The problem with inflation is it will give you lots of head fakes along the way… looks like it is turning down and then… BOOM ! (as my favourite football announcer John Madden used to say) it turns higher again. What do people think will be happening to commodity prices in another 12-18 months when the global economy is back in growth mode? And China is stimulating their economy? Oil? +$100 (perhaps much higher). Steel? +$1,000. Lumber? +$1,000. And if we actually get around to electric vehicles…. Copper? Other metals? Much higher. Inflation will rip again. And if the shortage of workers in the US is structural… more inflation. Ukraine war and then rebuild of their economy? Gonna need lots of materials… Please note, i am not doom and gloom. I think North America is going to outperform the rest of the world the next couple of years. And i really have no idea where inflation goes… but if it stays high (5%) i will not be surprised. And if you have a debt bubble isn’t the way to fix it to let inflation rip for 4 or 5 years (kind of what we have been doing the last 18 months) to bring debt levels down in real terms? That was the playbook governments and central banks used after WWII and it worked… looks to me like the same thing is happening in US and Europe today (especially Europe).

Ask any family if they think inflation is a problem. Food? Gas? Rent? I think +90% of families will say crazy high inflation is their top worry today. My guess is most businesses are building in inflation expectations of 4-5% when building budgets for 2023. (Those on the board with day jobs please correct me if i am wrong.) I think gold is most highly correlated with the US$ not inflation. When the US$ stops rising my guess is then you will see gold pop higher. (I think gold has been rising nicely when priced in euros or yen.)

@Spekulatius i think a number of things are happening at the same time. One thing by itself would be hard enough for companies/the economy to deal with. And they are all of different duration (some cyclical; some secular). Weave them all together and you have the reality of today. What is an investor to do? Be inquisitive. Open minded. And rational. 1.) covid - still not close to being over - largest economic impact today is general shift from goods to services - zero covid policy in China 2.) Into year 2 of high inflation in Western countries; currently at 8% - Fed policy has shifted from extreme QE (caused bubbles in financial assets: stocks, bonds and real estate) to extreme QT (burst bond and stock bubbles and is deflating real estate bubble). - inflation is starting to get entrenched into expectations. 3.) underinvestment for past 7 years/ESG/government policy has created a supply problem for energy. Result will be higher prices moving forward. Europe had an energy crisis well before Russia invaded Ukraine (yes, invasion made it worse…). This secular trend is inflationary. (Commodities are generally all in the same bucket here.) 4.) Russia invasion of Ukraine has created the greatest geopolitical crisis since the Second World War. Russia being one of worlds largest producers this is rippling through all commodity markets. And lots of other things. 5.) China has decided to come out. World is splintering into two blocks: West and authoritarian blocks. 6.) globalization is dead. Production is shifting from Asia back to North America and Europe. This secular trend is inflationary. 7.) others?

Added to Fairfax India at under $10. The only unknown is how much money i am going to make… and the timing. Like shooting fish in a barrel.