As a sector specialist, what to do when you sector is out of favor?

Sorry about the delay, earnings.

I’d break it down into pre election and post election (ie January and post inauguration), and for North America I separate Canada from US. Two years bullish. Near term, relative positioning is key. It is hard to be extremely bullish given inventory levels and terrible economic data.

From now until November I’m relatively bearish on US energy and bullish on Canadian energy. This generally applies to midstream and upstream (oil, gas, NGLS). Extremely bearish services 12m due to inventory. Although seismic companies will come back, timing is tricky for them.

What concerns me about the US is the perception that Biden is so negative oil and gas. I think it is more likely that he encourages development (Obama) while increasing taxes (revenue) to put into his nutty economic policies. I call this the hypocrisy of Norway plan (make the fools think you are “green” while trying to grow and tax production). But perception matters and we won’t known until after January, if we are lucky, what the real plans are. So negative US energy. Add to this a massive glut of gas in Europe, trade war with China and its very hard to be positive US natural gas (near term movement on warm weather has been very irrational for long term investors). While less associated gas is good for nat gas, Biden’s policies are far more negative, as articulated so far.

The caveat with midstream is the MLP structure. They might benefit (equity valuation) as corporate taxes increase. For non G&P heavy names (the large caps) it could be positive. These are also the companies that have cash flow to invest in renewables if included in the tax code for MLPs, however the return profile for these projects remains low and not competitive with current projects.

This is part of the pivot to Canada, too much risk now in the US. Valuations in Canada are generally attractive, debt levels tend to be lower and more manageable, P1 and 2P reserves are of much higher quality for the upstream, and I see less uncertainty. Also given the tremendous debt in the US and need for Trump or Biden to devalue the dollar, a pivot north could be smart. But needs to be re-evaluated post election and post inauguration. A simple way to look at it is would you rather own TRGP equity vs KEY CN equity? Both G&P but radically different balance sheets and assets. If Biden wins, the pressure on US midstream and upstream could be immense.

Of course lots of nuances with companies but I would be (and now am) overweight Canada, underweight most US, slight o/w exposure to DAPL given my view of resolution before inauguration.

Two years... geology says bullish. IEA and others pushing a false narrative that all is well. They need to push it. As long as there is a view that oil and gas are so abundant and cheap it’s easy to tell people to pay up now and save more later. But that isn’t going to be the case. They still think tight oil can fill the holes in production. Peak oil (supply) is here and likely being exasperated from the pandemic. Peak demand is a long way off. Inflation from all the money being printed to stave off properly functioning capital market and deploy money into expensive and destructive “green” energy is bullish for oil since it will drive inflation. And central banks will let inflation run, until it is too late.

The next 6 months is all about managing relative positioning at a country level. The bulk of capital for me right now is in midstream. And I’ve moved overweight Canada while keep some US exposure to avoid being too out of position. My gut is telling me that I should further reduce US exposure. But that could add to volatility vs benchmark. Utilities with a large midstream pieces are expensive and Biden’s anti gas rhetoric could hurt them, so that might not be all that safe a place to hide. Relative to pure US midstream though it ought to have more downside protection.

There are very few places that you can pickup 6-10% yields that are not MLPs and relatively safe. When you adjust the income return with a conservative view for valuation for volatility and maximum draw downs, Canadian and select US midstream are now offering up better returns then the SPX. That is something I like. I’ll happily clip an 8% return for my clients that want income, in a world where income is hard to find.

Long answer I know, and really only starts to graze the surface. There will be places that I’m wrong and will get my face ripped off. But on balance, I’m feeling good about pivoting North and becoming underweight and defensive in the US.