Description

We believe the fundamental outlook for oil prices is arguably the best in history where we expect many years of >$100 oil. We believe OVV is the best positioned E&P as 1) OVV has potential to generate over 70% of its market capitalization in free cash flow over the next year, 2) is pivoting to returning half that cash to shareholders in 1 quarter (ie best in class shareholder returns among E&Ps) and 3) they have over a decade of inventory in their core basins remaining. We believe OVV has potential to be a multibagger just based on the cash flow the company will generate over the next few years. We don’t have a strong view on 2025 oil prices but see no obvious path to market loosening and we will leave OVV fair value estimate at several times the current stock price. 

Oil Supply - We simply do not believe there is much excess oil capacity in the world with OPEC sitting at near record low capacity, non-OPEC/shale supply on the brink of decline and US shale largely unresponsive to higher prices thanks to newfound E&P capital discipline. 

• OPEC – while nothing is certain with OPEC, it is largely believed OPEC has 2mmbpd of capacity that they could add to market (Saudi and UAE). However, that capacity sits at near record low levels. Historically, if OPEC loses its spare capacity, oil prices run wild. However, given ~$80 fiscal break evens and anemic OPEC rig count, we believe it is highly unlikely OPEC adds capacity in this market. This runs similar to commentary French President Macron was caught saying to President Biden a few days ago where Saudi is saying they have no more production growth capacity.

  

• Non-OPEC/Shale – While hare to stereotype the entire ROW, it is obvious we have been underspending on oil for a decade. Oil prices have been low and its challenging/impossible to invest in new production growth given the rise of ESG and questions about LT oil demand. The estimated ~400kbpd of supply additions from effectively 4 countries is unlikely to offset organic declines from other countries? If ex-OPEC/US oil production is 60mmbpd and that declines at even 1% a year, that alone entirely offsets production growth from Norway/Guyana/Canada and Brazil. 

• US Shale – Anyone following oil market knows E&Ps are prioritizing capital discipline. While US rig count has gradually gone up, US production growth has largely been flat to date. I wouldn’t expect meaningful increases in US production from here.

  

Oil Demand – This is the question everyone is asking. Oil prices are highly unlikely to crack because of some unknown supply response that has broken the sector over the last 8 years, so demand is the key question. While we are not totally dismissive of the recession narrative impacting oil demand, we believe our starting point on demand leaves oil uniquely well positioned in the commodity world to survive a downturn. 

Firstly, oil demand today has not recovered back to 2019 levels. In fact, depending on who you follow, oil demand is somewhere between 2 and 4mmbpd below 2019 levels. Travel is still recovering (and despite some price action that implies people think otherwise, we view the travel recovery as fairly inelastic to demand today, and at least real time data confirms this). 

Secondly, while somewhat looped into the first point, China has been in a recession for all of this oil rally. It is reopening which will offset any demand destruction from ROW.

Thirdly, our inventory situation is highly precarious. Crude inventories sit below levels seen at any point in the last 5 years. While we are not sure the impact of the recently highly publicized 1mmbpd SPR releases on the part of the Biden administration, presumably oil dumping on the part of the US government which should end in October will have some positive impact on the oil price. 

• Timespreads further support view that the oil market is as tight as its ever been historically.

A word on Russia. We were shocked to discover that Russian oil production today as effectively back to pre-invasion levels. Sanctions on Russian oil should begin by Eurozone in January, which is yet another tailwind to oil prices.

To summarize oil macro. There is minimal supply growth coming as a result of a decade of underinvestment. Demand should continue to grow as a result of China coming out of downturn and inelastic travel demand continues. Russian Sanctions coming and SPR dumping will end which will provide further tailwinds. GS estimates market is 1mmbpd undersupplied today. We believe that will grow significantly as we go through the rest of the year thanks to the above. 

A natural question is where can oil prices go? We don’t know. Consensus thinks $150-$200/bbl will cause demand destruction. Maybe that’s right. However, we firmly believe oil is more likely to go up vs down in coming months. We also see no solution to fix this problem in medium term, rendering our view on fair medium term oil prices almost irrelevant to the E&Ps thanks to their significant cash generation. 

Ovintiv 

Valuation is particularly cheap vs other E&Ps

We would frankly buy any E&P right now. However, believe OVV is particularly undervalued. These E&Ps aren’t particularly hard to model any more given they are all holding production flattish and have given clear capex ranges. We believe it is easily conceivable to image $125 WTI / $5 HH next year given dynamics in oil/gas markets. Under these assumptions OVV would generate a 70% equity FCF yield. Moreover, on more reasonable medium term estimates of $75 WTI/$3.5 HH, the company generates a 22% FCF yield.  

Sellside broadly speaking agrees OVV should generate best yields at strip.

The opportunity on OVV is that they are pivoting from paying out 25% to 50% of their FCF in form of a modest dividend and heavy share buybacks in 3Q. This will positive them as the most shareholder friendly mid-to-large cap E&P.

OVV also has over 10 years of acreage in their core plays of Montney, Permian and Anadarko, but they should be very well placed to capitalize on the medium-term tightness in the oil market. 

Catalyst

Sustained oil prices

OVV Cash Return Increase