Oil Companies Posted Big Profits This Year, But Can That Trend Continue In 2023?

Rising oil prices helped energy companies to report higher profits in 2022. Greg Bonnell speaks with Jennifer Nowski, Portfolio Manager at TD Asset Management, about the potential impact of a slowing economy and weaker demand on profits going forward.

Transcript

Greg Bonnell: Higher oil prices lifted many energy firms through this year. But as we get to the end of the latest earnings season, what are we hearing from companies about the outlook going forward? Joining us now with more is Jennifer Nowski, portfolio manager at TD Asset Management. Welcome back to the program, Jennifer.

Jennifer Nowski: Thank you for having me.

Greg Bonnell: All right, so let’s talk about the key takeaways from earnings season when it comes to the oil companies.

Jennifer Nowski: Yeah. So earnings for the oil companies came in largely as expected this past quarter. The real highlight has been the year-over-year big increase in profits as oil and gas prices have been generally rising over the past year. And this has far outweighed any small increases in operating costs we’ve seen, particularly in the US.

If we look across the value chain for energy, there was a lot of big gains and profits year-over-year for the upstream and refining divisions. Chemicals, though, was weaker. This is due to higher energy feedstock costs, more supply in that market, and weaker demand.

Taking a step back and looking at the financial conditions of the companies, the sector’s been reducing debt, so leverage is at the low end now. And they continue to be very disciplined about returning cash to shareholders. We had a number of dividend increases, special dividends, more buybacks. And when you think about how much cash flow the sector is producing at today’s oil prices, roughly, the sector has a free cash flow yield of about 10% and into the teens. And much of that is coming back to shareholders.

Greg Bonnell: Interesting stuff. Good rundown of the quarter behind us. Going forward, what are you looking for from these energy companies?

Jennifer Nowski: So the big thing in the next few months is that the energy companies are going to come out with their 2023 capital expenditure budgets. In 2022, CapEx has gone up. And we’ve seen some inflation in the CapEx figures throughout the year. For 2023, the expectation, I’d say, is that CapEx will be higher again, partly due to inflation. And we’ll see how much is allocated to growth. In general, when companies talk about their — especially the large caps talk about their production growth plans, it’s usually at the low end of the scale, kind of 0 to low single digits higher.

Greg Bonnell: Now, investors this year have been so attuned to every headline, and depending on the asset class. When it comes to oil, no different. A lot of hand-wringing and journalism out there about supply-demand dynamics. How closely should investors be watching those dynamics right now?

Jennifer Nowski: Well, you absolutely should be watching them very closely. So what’s been happening is on the demand side, there’s been growing concerns about the impact the slowing global economy has on demand, as well as China, which is currently into some COVID lockdowns at times. So that is a headwind for demand. However, the supply side remains fairly well-constrained. You have a very disciplined OPEC, very limited spare capacity at OPEC. And the US is nearing the end of its planned releases from the Strategic Petroleum Reserve.

Now, this week one of the more debated items is the upcoming ban on Russian oil imports to the EU. And there’s debate about how much oil from Russia this could displace in the market. The offset, though, that’s also being debated is the implementation of a price cap that would keep Russian oil trading at the discount that it is trading at, but allow it to flow to other buyers.

Greg Bonnell: A lot of things to watch in that space. So that’s a great rundown about oil and gas, what we saw, what we can expect going forward, what we need to keep an eye on. What about the mining companies? How do they fare during earnings season?

Jennifer Nowski: Yeah. So the mining companies in general have had a tougher year this year, particularly on the cost side. So they’ve seen their profits squeezed in Q3. If you look at key metals like gold or copper, those are down year-over-year. So that was a headwind to revenues. And then the miners have really been battling cost inflation. Diesel is a big input, so energy has been a headwind. Sometimes, supply chain challenges still earlier this year. Transportation was higher earlier. So all headwinds to costs.

The other thing too, mining is a very difficult business. Some have missed on their production targets. And this is for a variety of reasons, some due to continue to working through COVID challenges, others typical weather or operational issues. Problem, of course, is when you’re light on production, your unit costs go up. So that can be another challenge.

So the big thing going into 2023 for the mining companies will be that outlook for costs. Energy is going to do what it’s going to do. Labor costs might be stickier, higher. And maybe we’ll see some relief or flattening on transportation or some of the consumables.

Greg Bonnell: All right, we talked about supply and demand dynamics and how it drives, obviously, the price of crude. Same thing for a lot of these metals. Let’s talk about the metals space right now and what we’re seeing there. I think of demand, and then I think of China and some of the constraints there, or the possibility of recession. How does it all play out?

Jennifer Nowski: Yeah. So metals prices — and we’ll talk copper because it’s kind of the bellwether. It’s been weaker since about the middle of this year, again, on concerns about slowing demand from China, slowing demand globally. The copper price, though, has kind of perked up the past few weeks. And there’s sort of three reasons for it. The first is the weaker US dollar. So metals are priced in US dollars, and a weaker US dollar makes it more affordable to the rest of the world. The second is China. They came out with some announcements to try to support its property sector, which would be positive for metals, as that’s a key consumer. And the third, although, like I said, China is battling some COVID outbreaks right now, sometimes investors start to look forward into the next year and wonder if we might be entering a period where China could relax or loosen some of these COVID restrictions. So that’s still uncertain. It remains to be seen. But at times, it’s put some optimism into the copper price.

Turning to the supply side for copper, the story is still — we’ve had a few mines come online this year. But as we went through Q3 and part — more recently, you do see existing mine production struggling, particularly out of Chile’s Codelco, which had to bring down its production guidance. So that provides some offset to the new mine supply.

If we think longer term, of course, the long-term demand for copper tends to be brighter. It’s exposed to the electrification theme. And then a couple of years out, it becomes less clear where new supply will come from to meet this demand.

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