Hello and welcome back to The Institutional Beat podcast, where we cover interesting and relevant topics for institutional investors. My name is Julie Ducharme. I'm an institutional portfolio manager on the PH&N Institutional team, and I'm also your host today. Now, as many are aware, Canada's energy sector is a critical growth driver of our economy and it represents the second-largest investable sector of our Canadian equity index.

But unlike some of our sleepier sectors, this one is constantly evolving. You know, everything from regulatory hurdles to shifts towards sustainability. Now we're fresh off the First Ministers’ meeting that happened at the beginning of June, where there was an agreement on the urgency of producing both conventional and clean energy, with projects touching many areas used by the energy sector.

Railways, ports, pipelines, electricity transmission, just to name a few. And so today we're going to explore what this, what I call “energy urgency,” means for institutional investors and whether that's more over the near term or longer term. And it's my pleasure to introduce our guest today, Sarah Neilson, my colleague, who is Managing Director, Senior Portfolio Manager, and Co-head of our North American Equities team here at RBC Global Asset Management Inc.

Sarah spent her entire career covering the energy sector, so who better to tackle some of our burning questions with? Sarah, thank you so much for joining The Institutional Beat.

Thank you so much for having me.

So Sarah, help me understand, why is energy so front and center for our leaders right now? Is it because of some major barrier that is stunting the growth of our sector over the past years? And, you know, are there some obvious ways to unlock this?

Yeah, it's a great question. And it's, somewhat comforting to see it front and center these days. But you're right, there have been issues that have impacted the Canadian energy sector for many years. And, we do have abundant oil and gas resources in in Canada, specifically in the western provinces. And we've been plagued by limited access pipeline capacity.

 It's been in the news, you've seen it on the oil side specifically. And that's largely, the producers grow, they fill the pipes. And then the demand for the incremental production is south of the border largely, or globally – not internally. So we have to find a way out of our country. And when it gets bottlenecked, we see this crude traded in Canada at a discount.

And this has happened even on the natural gas side where again, abundant resources and a global desire to get at them, but inability to get them to where they are demanded. So, prices have been discounted and that has impacted the valuation of Canada's energy stocks. And then as well, policy certainty is in front and center for many years.

So it's permitting of new infrastructure projects, permitting of new development projects, carbon costs. What are they? We have a plan in Canada, but is it going to be there for the long-term? Uncertainty on fuel regulations. So that's a really challenging dynamic for a company to invest in. If you don't know what the rules of the game are and if they're going to shift all the time, and it's very challenging for investors too. You can't forecast your potential return if you don't understand what those rules will be.

So I think those have been the biggest areas that have impacted the prosperity of the sector. I mean, it's still quite prosperous, but could it grow beyond that? And those are the areas that we're really focused on.

And is there like a wish list from the energy producers? I mean what are you hearing from your discussions with some of these companies?

Yeah, we're very fortunate to have access to speak to a lot of the biggest Canadian companies on these issues and ask them specifically, what is it that you need to see from our new government? And one thing is streamlined and clear permitting requirements. Some projects have taken up to five years or longer to receive a permit – that's a lot of time and money and people, just to get to the point where you can invest. And by then the cycle may have moved completely. So, looking for that to be tighter and clearer for who needs to be consulted and how, so hopefully instead of five years we can get to two years, I think is the goal.

And you know, even recently we've seen this one Canadian economy bill that's been tabled and that is speaking to try to get to that place. So, in carbon policy clarity, like I said, not only is the pricing which needs to be decided between the provinces and the federal government and I have faith that will get there, but there's also a carbon cap being proposed on the energy industry. So, what the industry would like to see is that cap go away, and they focus on reducing carbon intensity of the production. So over time, we have a lower carbon intensive barrel or molecule being produced. And I think from that we'll see support for the pathways initiatives which we've heard of in Western Canada, which is a focus on reducing the carbon footprint of the oil sands by investing in carbon capture technology and additional technologies.

And lastly, I mean, there's so many, many little things. But I think also eliminating the tanker ban off the BC coast is on their wish list. So lots of discussions happening about what that wish list is, and how we can get to a common ground. But it's encouraging.

You didn't mention too much about pipelines there. What's their role in fueling our energy exports? You know, where are we today? Do we have decent capacity? Are there some shortcomings for where we need to be?  

Well, so they are very critical, like I said, in terms of alleviating bottlenecks. And we did have the Trans Mountain Pipeline that was expanded last year come online. And while it's not full to the brim, it's actually full, almost as full as it could be with firm transport contracts. And so there is a need for that pipeline and there is potential to see that expanded over time, as well as many of the other pipes across the border.

They're all looking, I know these infrastructure companies are looking hard at where they have opportunity to increase capacity to reach different markets or even reach just the U.S. Gulf Coast. So I expect we'll hear more about what we call brownfield expansions. And then also potentially new builds are being tabled. And those are more challenging to see them come to fruition, but with the right fiscal framework and support for those, by the federal government and the provincial government, we could see another crude oil pipeline built in this country. But I want to switch to natural gas, where I think Canada's got an exciting story. We will be exporting our first liquefied natural gas off the West Coast this summer, I believe.

I think we're getting a tanker shortly, from the news reports we're seeing. And this is a really exciting over-$40-billion project that will be coming online to help take Canada's gas to Asian markets. And that really does provide a nice demand center for our product, but we need more. We started at the same time as the U.S. trying to export natural gas, and they have, usurped us, for lack of a better word, and getting to a place where, they're seeing large exports and they're growing exponentially.

And we have one, with another two slowly in, making progress. But I think that we'll need more pipelines to grow our LNG industry. And I think there's some real potential there. So with the backing of our government and a positive policy backdrop and the economics working for both the pipeline builders and the producers, we could see some momentum as well.

It's interesting to have crude oil and gas no longer be four letter words as part of our rich export economy. But I'd be remiss if I didn't broaden the conversation to talk about, how we're doing on renewables. I personally live in a province (Quebec) with a very rich hydroelectric power grid, we have nuclear that is also front and center for a new constructions. Where's your outlook at on this segment of the market? And does it have a prominent place?

I really do think it does. I mean, if you think about the growth in electricity demand that's being forecasted across North America from – in Ontario, I think it's significant growth, I think in the U.S., we hadn't seen electricity demand grow for decades, and now they're forecasting 10% plus electricity growth. And what's that from? Well, part of it's electrification.

We've seen a larger push to electrifying our lives more and reduce the greenhouse gases from other things. So transportation and EVs being one predominant area there, as well as data centers and what we call hyperscalers building these large, very energy intensive campuses to support our ChatGPT habits. And they are growing exponentially all over the U.S. and I think we'll even see some growth in data centers in Canada.

And the power demand from those, are increasing that electricity demand. So we need, like I say, all hands on deck for this. Renewables are very low cost. They're quick to construct. And they do serve a very important purpose of lowering the carbon footprint of any electricity grid. That said, they are intermittent, which means they don't – the sun doesn't shine all the time and the wind doesn't blow all the time, so any one electricity grid can't rely on only renewables without batteries as backup or something. So we need a baseload. So that's natural gas generation, and also in some cases where applicable and increasingly applicable, is nuclear. Like you mentioned. I think there's a really growing, exciting need for nuclear. And we've even seen over the last few weeks in the U.S. more of a call to growth on the nuclear side.

We hadn't seen that in many, many years. And partly because we're seeing technology evolve for nuclear that sees smaller-footprint generators and reactors that are, I wouldn't say easier to construct, but maybe faster. And lower capital cost upfront, which means you get to the point where you're getting cash flow faster and the economics make more sense.

So I think we're really well positioned in Canada to see more nuclear growth as well. I mean, in Ontario, we've got a number of plants. We're working on the first SMR (small modular reactor) and the Bruce Nuclear plant has already slowly grown some of their nuclear projections as they've refurbished their units. And I think even across the country, we're having people look at nuclear opportunities. It's really exciting.

And it makes you wonder if one day we'll have, you know, very rich subsectors of our indices that represent new SMR producers or data center producers, for example. So I have to ask, as an investor and looking forward, maybe over the near term and maybe longer term, are there segments that are obvious winners in this? And maybe on the flip side, some that you are being cautious about?

It's a great question. I'll start with the energy producers. I do think as we get through some of these bottlenecks and see more policy clarity, we could get to a place where the valuations for the long-dated resources could appreciate. And we think that that's really encouraging for a sector that has not really seen that that kind of attention in a long time.

So, that's positive for us. But where I think we could see some additional growth and valuation upside is the infrastructure companies. So building new pipelines, building new transmission grids, that's more on the utilities, but also building liquids infrastructure and all the infrastructure that goes in the backbone of producing more energy, especially natural gas energy in Western Canada --  there is a lot of infrastructure growth that can come from that, and building new LNG (liquefied natural gas) plants. And this also leads into the industrial sector. You think about, there's a lot of demand for different industrial machinery, and engineering companies, and then if we do build out more nuclear, which I'm pretty convinced we will, there's demand. We have nuclear specialists in Canada.

And so there are some companies there that will benefit, as well as the uranium miners will through the long term see a nice base support for their product. And lastly, I'll just say on the utility side, we've already seen some of the utilities in North America recognize value for the growing electricity demand I spoke of, but I think there's still some pockets and areas where there's still the ability to see valuation upside, where power gets contracted longer term than we ever thought by a data center at an attractive price, which elevates the valuation of some of those power generators.

And I think those are areas we're really focused on, and thinking about, how we can continue to create value for our unit holders.

Well, Sarah, thank you for taking us through what was ultimately a pretty quick look at the barriers and the opportunities to very complex sectors, like pipelines and renewables. But, you know, it strikes me that the Canadian energy industry could be at a very important inflection point today, both politically and at business levels, whether it's on traditional, with things like new LNG plants or new crude pipelines, arguably, and then there's a lot of excitement on renewables like accessible nuclear, if one can say such a thing.

Right?

And so the decisions that are being made today by policymakers, businesses, and I think those of us as investors are going to shape the role that Canada plays in our and the global energy economy for decades to come. So thank you for sharing some of your expertise with our clients. And thank you for joining us.

Well, thanks for having me. Really excited about this.

Wonderful. And if you enjoyed this episode, don't forget to subscribe to the podcast so you can listen in on future updates. We hope you can join us again next time.