All sectors took a dive in 2022 – except energy. While the Morningstar Global Financial Services Index was down 3.06%, the Morningstar Global Real Estate Index was down 19.2% and the Morningstar Global Information Technology Services Index was down 18.53%, the Morningstar Global Energy Index shot up 43.78%. The Morningstar Canada Energy Equity Index was up 46.32%. All the Morningstar Index returns are in Canadian Dollars.
Among the energy sector stocks, however, some did better than others. With an eye-watering return of 120% in 2022, Occidental Petroleum stock (OXY) was elected “2022’s Stock of the Year” by MarketWatch.
“While it's true that Oxy consistently delivers peer-leading well performance as measured by initial production rates, that doesn't tell the whole story as its wells also decline more quickly. Even so, we rate the acquired acreage of Anadarko Petroleum in 2019 highly and believe Oxy can compete with the top Permian firms on profitability,” said Morningstar analyst David Meats.
On the other hand, Major Canadian oil stocks didn’t shine as brilliantly, but still performed well. Canadian Natural Resources (CNQ) gained 28% over 2022, Imperial Oil (IMO) 25%, and Suncor (SU) 22%. Surprisingly, while the S&P TSX P/E ratio stands at 14, that of these companies oscillate nearly 50% below that between 7 and 8. Morningstar analysts do not cover these stocks.
Oil Prices Will Come Down – And So Will Energy Stocks
The behaviour of oil itself has a lot to do with the success of energy stocks. 2022 saw a WTI barrel 10-year peak price of US$124 following the invasion of Ukraine in March of that. After hitting US$ 22 in June, the price per barrel of WTI crude slowly receded to US$77 in early 2023. Most oil stocks followed that slide, with their strong performance in the first half of 2022 slowly eroding in the second half.
And the WTI price should continue to slip to US$65 in 2023, predicts Victor Vallance, Managing Director, Energy, Utilities and Natural Resources at DBRS Morningstar. “That projection is rather conservative,” he readily acknowledges, but it is not that far off other estimates. For example, Curtis Gillis, Portfolio Manager of the CI Global Resources Corporate Class fund expects prices to average between US$70 and US$80, a projection that replicates Stefane Marion’s, Chief Economist and Strategist at National Bank of Canada.
“We think 2023 will be volatile like 2022, since so many factors can have an impact on pricing, Vallance warns. Prices could go up or down.” At the end of 2022, he states, “key factors weighing on prices include demand concerns with respect to slowing global economic activity and China’s tough lockdown measures to cope with another serious wave of the coronavirus disease.” Let’s note that the most recent developments point to a positive evolution of the world economy and of China.
He also indicates two other elements in the price mix: the constraint on supply resulting from the sanctions and price caps imposed on Russian oil exports by Western nations, and the challenges OPEC+ countries have in meeting their allocated production targets.
All these factors can combine in unexpected ways to push oil prices up or down. For example, an economic soft landing and a vigorous reopening of China could change the outlook and cause Vallance to revise his projections, possibly in the same range as Gillis and Marion.
Don’t Expect Energy Stock Price Returns of 2022 in 2023
Given the lower price of oil, it would be surprising if oil stocks experienced another strong year in 2023. To begin with, companies are operating at a slow burn rate and are not planning any capital expenditures focused on growth.
“Companies have taken advantage of robust prices and have prioritized employing excess free cash flow to pay down debt and return capital to shareholders, Vallance recently wrote in a commentary. For our rated oil and gas issuers, balance sheets and key credit metrics are the strongest they have been in years.”
Indeed, very little money is going into exploration, which is at an all-time low. “Investment is going in low-risk development opportunities, in cost efficiency and decarbonisation programs of the production processes,” Vallance wrote.
How Much Might Energy Stocks Gain in 2023?
That is not to say that oil stocks will be duds. Granted, “there won’t be any expansion of multiples, stocks will be essentially linked to the behaviour of the underlying commodity,” says Benoit Gervais, Senior Vice-President at Mackenzie Investments and Portfolio Manager of the Canada Life Global Resources fund. However, because companies are so focused on returning capital to investors, “I expect a return between 10% and 15% when you combine dividends and share buybacks,” he adds.
Curtis Gillis shares that view: “These companies are paying good dividends to shareholders, so performance of equities should be still quite good. But it won’t be the records of 2021 and 2022. With oil prices stabilizing at a healthy level, many companies will hit their leverage targets in 2023, at which point they intend to allocate a greater portion of their free cash flow, some up to 100% of free cash flow, to dividends and share buybacks. It is this high cash distribution to shareholders, especially relative to other sectors, that is likely to maintain investors' attention in 2023.”
