Global energy markets are facing unprecedented disruption. With one-fifth of the world's crude oil, natural gas, and refined products constrained by the Strait of Hormuz closure, we're seeing ripple effects across everything from gasoline prices to fertilizer supply.
The uncertainty isn't just about the immediate impact – it's about duration, recovery time, and what happens to global supply chains even after de-escalation begins. This creates both challenges and opportunities, particularly for investors looking at energy assets with long-term stability. In this video, Jesse Coote, Associate Portfolio Manager from RBC North American Equity team, discusses what this means for your portfolio and where security of supply matters most.
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Jesse Coote - Associate Portfolio Manager, RBC North American Equity team, RBC Global Asset Management Inc.
How are you currently assessing the dynamics in global oil markets?
As a result of the closure of the Strait of Hormuz, one-fifth of global crude oil supply is constrained: one-fifth of natural gas exports, one-fifth of refined products (so gasoline, diesel, jet fuel), over a third of helium supply, over a third of urea (which is used in fertilizer), and over a third of sulfur, (which is also used in fertilizer).
There doesn't seem to be a path to near-term de-escalation. On crude oil: globally, refineries rely on the crude oil that comes out of the Persian Gulf. It is a specific grade, a lot of it is medium sour. It's very hard to replace that. No two barrels of oil are created equal, so you can't simply run a barrel of light sweet from the U.S. and replace a barrel of medium sour from the Persian Gulf because what you put into a refinery determines what you get out.
Additionally, the cost of crude oil has gone up, which means the cost of refined products has gone up. On refined products: the Middle East is also a major refining hub. Refined products are now shut in because they can't transit through the Strait of Hormuz, which means globally, we're also short on refined products, in addition to the input cost being much higher. On natural gas, we export liquefied natural gas.
One-fifth of global supply transits through the Strait of Hormuz, and one-fifth comes from a single plant in Qatar. We're exiting winter now, which means that we're at a point where Europe in particular is starting to refill inventories ahead of next winter. And now, with the shortage of supply, they're competing for cargoes against Asian customers. So it's driving the price of natural gas up.
This is also problematic for transportation fuels because natural gas is also an input for distillates like diesel and jet fuel. So there’s more pressure on refined products and more pressure on transportation fuels. There are two challenges ahead. The first is that we don't know the duration of the conflict. The longer it goes on, the more we exacerbate the challenges ahead and potentially the price of commodities.
The second is that even if we had de-escalation tomorrow, it will take a long time for us to resettle flows. We're not sure of the extent of the damage to facilities like refineries, LNG plants, or export terminals. It will take a long time to rebalance flows of cargoes going through the Strait of Hormuz. So the uncertainty is driving a lot of volatility in commodity prices as well.
Which types of companies do you believe are best positioned in this environment?
Conflict like this emphasizes security of supply, safe jurisdiction, and asset quality. Canadian heavy oil producers possess a lot of the qualities that we look for. They have asset duration, they have reserves that are measured in decades, not years like other producers, particularly shale producers. They're low decline. So, their assets don't decline as rapidly as U.S. shale, for example, which means they have to spend less capital to maintain production.
These producers also produce substantial free cash flow down to $50 oil prices - some even below - and their balance sheets are clean, which means that when we go through commodity price spikes like this, the incremental free cash flow accrues to shareholders through more dividends and more buybacks.
They're more resistant to putting capital to work on the ground to rapidly grow production; they're more sustainable through the cycle. So, we look for companies that have the asset duration, high quality management teams, and strict adherence to free cash flow or shareholder returns because we get better returns through the cycle as opposed to just during commodity price swings.
The vulnerability of supply really highlights asset duration and quality, which is why we expect to see a premium valuation in Canadian energy. Moving forward, if the duration remains prolonged, that places more emphasis on asset quality and duration, which should benefit Canadian energy producers as well as field service companies that help them develop those reserves.