Editor’s Edition: Will recession fear keep clobbering oil and gas stocks?

Recession fears are overrunning a fundamentally strong market for oil and gas, sending stocks and benchmark commodity prices lower as investors weigh the possibility of an economic downturn that saps demand for fuel.

Kevin Krausert is CEO and co-founder of Avatar Innovations, a Calgary-based venture capital firm and startup accelerator that pairs entrepreneurs with the biggest companies in Canada’s energy patch. He says the industry is “very healthy” at US$70 per barrel, after the benchmark North American price fell from US$122 in June.

“This is still a very cash flow positive, strong industry,” he told Yahoo Finance Canada’s Editor’s Edition. “There’s obviously a certain amount of caution based upon the uncertain world we live in. But by and large, there is a lot of confidence in the energy industry.”

In this episode, Krausert discusses the risk of Canada being left behind as global oil producers strive for cleaner barrels. He also weighs in on EV week in Canada, which has seen politicians make funding announcements for charging infrastructure from B.C. to P.E.I.

Got a question for Kevin Krausert? Email Jeff.Lagerquist@yahoofinance.com and let him know what interests you in the world of clean energy and technology.

Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.

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Video Transcript

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JEFF LAGERQUIST: Welcome to "Editors Edition." I'm Jeff Lagerquist with Yahoo Finance Canada. The biggest party in Canada's oilpatch is in full swing. The Calgary Stampede is a closely watched gauge of the energy industry's health.

We'll find out if tumbling oil prices and recession fears have put a damper on the fun. We'll also talk about where Canada stands in the global race to produce cleaner oil. And it's EV week, so we'll spark up some discussion about that.

Joining me to break it all down is Kevin Krausert. He's CEO and co-founder of Avatar Innovations. It's a venture capital firm and startup accelerator that pairs entrepreneurs with the biggest companies in Canada's energy sector. Welcome, Kevin.

KEVIN KRAUSERT: Welcome. Good to see you. Happy stampede. [LAUGHS]

JEFF LAGERQUIST: Yes, to you as well. So I mean, the 110-year-old event is, of course, famous for rodeo pancake breakfasts and all, sorts of, crazy food. I think this year I saw cricket dogs, onion, and garlic lemonade, and mac and cheese ice cream. I'm not sure if I'm terribly interested in tasting either of those.

But more importantly, for our purposes, the stampede brings together leaders and powerbrokers in the energy industry. People like me tend to keep a close eye on how much companies are spending on sponsorship events and things like that, suss out the mood of the industry. So Kevin, as you're rubbing shoulders with the bigwigs over there in Calgary, what's the atmosphere like?

KEVIN KRAUSERT: Well, after two years of pandemic, this is definitely the most exciting stampede I've ever seen in my life. For those outside of Calgary, the stampede is really a unique cultural event for Canada, where the entire city gets involved in a week-long celebration, it's a community event, but it's also a corporate event.

And so this year, it's been event overload. I don't even know how many events I've been to over the past eight days. I'm going back to the stampede as soon as this is over. But the excitement is palpable. It's not just this coming out of the pandemic, and seeing people, and networking for the first time. I'd say there's a certain amount of optimism around where the future of the energy industry can be.

I think that increasingly, there's a realization on energy security, Canada's role in delivering energy security in a voracious energy demand environment. I think there's a lot of optimism around the role that oil and gas industry can play in the energy transition and the investments that many of these companies are taking.

And so it's a lot of fun. It's been some incredible networking. And Calgary-- you can't get a hotel room or a rental car in Calgary right now. But I think the reality is, it's a barometer of the health of the energy industry. People are like, oh, well, this is three stampedes packed into one because we haven't had really a stampede over the pandemic. But I think it's actually more like eight stampedes into one.

From the 2015 to 20-- to the pandemic, you had years of depressed activity. And during those periods of layoffs, a lot of corporates were reining in their expenses, understanding how-- it was inappropriate to throw a big blowout party when you're doing layoffs.

So this is like eight years of stampede into one. The governor is off. But there is not just an optimism around the role the industry can play in the future, but also the role, the industry can play in the energy transition. And so it's good times in Calgary this week, but it's also a lot of hard work. [LAUGHS]

JEFF LAGERQUIST: So not to detract from the euphoria, but I want to take a look at the price of oil since the events started on July 8th. If we take a look at that chart there, we can see the North American benchmark falling throughout the week here. WTI peaked at $122 back in June. And I think we just touched $92 per barrel shortly before we started recording.

Let's also take a look at the iShares XEG ETF and see how that's fared during the stampede so far. That is a basket of large-cap energy stocks. The biggest holding there being Suncor, Canadian Natural Resources, and Cenovus. Those stocks have also fallen off their highs since early June.

So Kevin, obviously given the strong start we saw to 2022, do you get the sense that there is any worry beginning to feed into executives and investors as they look at these charts?

KEVIN KRAUSERT: Yeah, the primary driver of all of this is called caution about a recession, or at least the fear of a recession. You're seeing inflation grow at a pace that we haven't seen in decades. Central banks increasing interest rates to cool the economy back into the productive capacity that it has.

And largely driven by supply chain disruptions where you had a global economy that was designed around just in time to supply chain that was underinvested in it over the pandemic. And now the world turns back on, leading to cost rises across the economy.

Smaller subset of this is obviously the war in Russia, where Vladimir Putin has moved his ground war in the Ukraine to a broader economic war with Europe in westernizing-- weaponizing energy. So this is causing investors to flee to safety. And it's why you see not just a drop in energy equities, but you also have seen a drop in technology equities even more dramatically than you've seen.

So wherever you have this assumption that an investment is made on future cash flows and you have these fundamental washes in the economy, it's only logical that these types of things would creep in. But the reality is the Canadian energy industry is very, very healthy in $90 a barrel. It's very healthy at $70 a barrel.

So while I think you're seeing this pullback based upon recessionary fears, and perhaps Europe already is in a recession, the question is, this is still a very-- they're very cash flow positive strong industry anywhere in these types of price bands.

And so there has-- after 70 years of depressed energy prices in Canada, the wild enthusiasm that we would outspend cash flow again or go back to just drill our way out of this, that was never even the mindset a month ago when prices were at $120.

So I'd say there's obviously a certain amount of caution just based upon this uncertain world we live in. But I think by and large, there's a lot of confidence in the energy industry at least. And Canada is very strong at this price band that we're in.

JEFF LAGERQUIST: So I keep hearing that inventories are incredibly low and we're in a very tight supply situation. And all the analysts are saying that fundamentally, the oil market is very, very strong. And I think that probably for a lot of retail investors, looking at their portfolios, today they're seeing a mismatch between that commentary and what's happening. Can you walk me through some of the fundamental indicators investors can look at if they're starting to get nervous about oil and gas stocks?

KEVIN KRAUSERT: By and large, it's excess capacity and it's production. What I would be looking at right now is really the economy. And GDP is going to be the key measure to be watching for a recession.

Do we go into a light recession of one or two quarters, cool off the economy? Prices are going to stay where they are. Indications of perhaps deeper recession is obviously going to be labor numbers. That's the barometer that most people use.

And right now, we're still at record low unemployment, which is the really interesting thing about this recession, is how do we have-- how are we walking into a rest recession with record low unemployment?

So the question is-- a short-lived one or two quarter recession, I think, arguably could be made that would be of benefit to the broader economy. A deeper recession, you've got to start looking at unemployment numbers, housing numbers, these types of things. Because it's not the fundamentals of the oil market, it's the fundamentals of the economy that are driving the speculative drop in energy equities.

JEFF LAGERQUIST: Where do you see crude prices going from here? I think Scotiabank recently forecast $104 in 2022 and 95 in 2023 for WTI. What are you looking at in terms of the actual commodity?

KEVIN KRAUSERT: I think-- first of all, forecasting energy prices is a fool's errand at the best of times, let alone in this amount of uncertainty. But historically, during a recession, the oil industry and the energy industry have not fared well. And that was because you had-- always had oil production and oil investments lagging market signals.

So you had the energy business, which consists of many multiyear multibillion dollar investments, they've become hard to turn off when the economy dips. So even if you had a little bit of demand destruction in a recession in energy and production staying near constant, you'd get these wild swings and oil prices that would make material impacts on the bottom line of producers.

But the difference this time is the investment constraint. Since we've had high energy prices this past year, producers-- investors will be telling producers to pay down debt and buy back shares. Not to go and reinvest in increased production. So this is what's leading to this very supply constrained energy market.

And so I see the energy industry faring off better than other sectors in this recession. Because during this period of high energy prices, when historically we would have gone back and drilled, this time, we paid down debt and bought back shares. And then you layer on this geopolitics of Russia, I see the energy industry as perhaps fairing-- being a strong, safe commodity through a recession.

JEFF LAGERQUIST: So inflation is a big part of the story here. We saw the Bank of Canada deliver a larger than expected rate hike yesterday in a bid to get that under control. What will a higher interest rate environment mean for energy companies and maybe some of the projects they're looking at doing down the line?

KEVIN KRAUSERT: Simply put, it increases the cost of capital a little bit. Most of these producers have term debt. You've seen a few deals been happening recently with acquisitions that have been debt-driven, but they would have been term debt. So it might cool off some of the acquisitions, but I don't know how much.

And then in terms of the big projects, well, there really isn't a lot of big energy projects on the books right now. Where I think perhaps the bigger risk would be is on some of the major energy transition projects that are being contemplated from hydrogen, to carbon capture, to small modular nuclear reactors.

These projects are going to take a decade to build. And in a period of rising inflation on that type of capital spend, your-- in rising interest rates, there's going to be a resetting of some of these expectations. Also on solar wind. And a lot of those projects were predicated on cheap debt.

And are we in a period where we have high expensive debt to cool off the economy and then it returns? That's where I would be watching. And I think it also speaks to the need that if Canada wants to be a true partner in reaching our net zero goals, then it's going to require us to build these major energy transition projects. I think it speaks to the role the government needs to play being a true partner and de-risking some of these investments in an era of increasing volatility.

JEFF LAGERQUIST: Well, Kevin, you used to run an oilfield services company. How impactful is inflation at this level when we talk about day-to-day operations? Companies need to put fuel in their trucks, they need to buy materials, and manage those expenses.

KEVIN KRAUSERT: So if you're running a smart service company, you're probably trying to offload many of those costs increases onto the producer, which is making increased revenues from increased prices.

But if you're in a low margin business and you see the type of inflationary rates we're seeing right now, it is going to cause you to pause and think about capital investments, tighten down your cost structure. That's prudent financial management, which, I think, speaks to this uncertainty in the market right now.

JEFF LAGERQUIST: Let's talk about the broader picture for oil. US President Joe Biden is in the Middle East this week, looking to reset relations with Saudi Arabia, the world's largest oil exporter. Heading into midterm elections this fall, Biden is surely looking for more oil to combat high fuel prices in the States. Kevin, do you think the Saudis will be receptive to this request? And what is their capacity to actually add more supply to the market?

KEVIN KRAUSERT: So Saudi Arabia's role in the energy market has historically been one of the most important, if not the most. It's the largest producer of oil in the world with the lowest cost structure. They've always placed an outsized influence on the market.

And right now, with Russia as the second or third largest producer and the world basically deciding that Russia is no longer a reliable producer of energy, Saudi's role has only increased.

Also the US is the largest consumer of oil in the world. And relations have been strained over human rights questions in the United Kingdom. But the reality is, the US can't afford that stance anymore. And the human rights abuses in Saudi Arabia are, I think, a different magnitude order of awful, compared to the war crimes that Russia is committing right now.

So I think Biden is trying to warm relationships with the Saudis. And having actually gone to school in Saudi Arabia, you have seen some liberalization in Saudi Arabia over the last few years. Women restrictions have been loosened, the Mutawaa, the feared religious police have been pulled in.

So I think it's a bit of a simple-- it's overly simplistic to say that Saudi Arabia is not modernizing. So I think there could be some areas obviously for collaboration to bring the Saudis into a responsible energy mix of the future.

In terms of the production capacity, they could add to the market. Nowhere-- I think they're sitting somewhere 14 million barrels of oil a day and Russia, 12 or 11. There's no way the Saudis are going to be able to replace the Russian oil market. But if they could bring on a million barrels of oil a day, which I think is about their stated goals, that would have a cooling effect on inflationary prices or inflationary inputs for the world.

JEFF LAGERQUIST: So Biden first spoke about increasing short-term oil supply months ago as the Russia-Ukraine war was heating up. I think there was some disappointment in Canada that he didn't come to us first. Part of that idea was based on this idea that Canada's oil is more ethical and green. You say were at a recent panel talk with former Bank of Canada Governor Mark Carney when this came up. Can you tell me about that discussion a little bit?

KEVIN KRAUSERT: Yeah, I was at a conference speaking right before Mark Carney, and speaking about the role the oil and gas industry can play in the energy transition. And there was some question around, was Canada the only country actually trying the energy transition? And are we putting undue costs on the Canadian energy industry, while global players might be less concerned, putting us at a competitive disadvantage?

And I don't know where this perception came from that the rest of the world isn't doing as much, if not more, than Canada is on this. If you take the top four oil producers in the world, Saudi, Russia, US, Canada, that's about half of the global oil production. Then after that, you start jumping down to producers that are in the one or two million barrels of oil a day of production. So immaterial in comparison to the big four.

And so let's break out those big four right now. For sure, I don't think the Russians are having a conversation around carbon capture right now. They're probably having a conversation about how to pay their bills next month and maintain liquidity. But the Saudis are, the Americans are, the Europeans are.

Saudi Aramco is committed to net zero by 2050. They've been investing tremendous amounts of money into solar, into hydrogen, into wind. And I think it would be a major mistake for Canada to discount the largest oil producer in the world, which is a highly sophisticated company, to somehow say they're not factoring in the strategy to win in the energy transition. And secondarily, the Americans are running at this faster than they ever have before with way more risk capital.

So if you stack Canada up against these types of global energy superpowers, which we need to, and not these sort of immaterial, small producers, of which there are dozens, Canada can win this race. And that's the conversation we need to be having as a country, is how do we responsibly produce oil and how do we use that revenue and that source to invest in the transition so we can win the race to net zero that is going to include a thriving oil and gas sector?

JEFF LAGERQUIST: Is there a risk that some of these other countries will pull ahead of Canada on energy transition initiatives? I know that, of course, our oil sands are energy intensive to produce and refine and everything. And that's not the case over there in Saudi Arabia. And of course, there's lots of money in Saudi Arabia to bankroll all kinds of carbon capture projects and things like that. Will we get left behind at some point?

KEVIN KRAUSERT: I think there is a risk, but I think the biggest risk is actually on a regulatory front. Do we keep changing regulations for major projects to the point that every major project has to go through 17 different regulatory approvals that takes multiple years?

Germany just committed to the regulatory process for energy transition projects to be shortened from six years to one year. We need to be thinking about those types of measures as well too. Because if we want to hit the emissions reduction targets we have by 2030, and it takes five years to get regulatory approval and then another three or four to build it, guess what? We've missed the boat.

The second area of concern I have is really around risk capital. There's a lot of risk capital available for these types of emerging technologies in the US that is unavailable in Canadian markets. So that's another area we need to be thinking about if we want to win this.

But the good news is, I've never been more convinced in the resilience and the capabilities of Canada-- Canadians to come together in this hour of need. And I think if we can solve those two things, I think we can win this race.

JEFF LAGERQUIST: Kevin, we only have a few minutes left. But let's shift gears to another part of the energy transition. According to the Federal government, its EV week in Canada. From PEI to BC, politicians have been busy announcing new charging stations and other infrastructure.

Ottawa wants all light passenger vehicles in sales to be zero emissions by 2035. I think the key word there is sales. I have to make sure that I say sales will be all electric or all zero emissions by 2035. You raised a great point earlier when you mentioned the retirement rate of internal combustion cars. What does that tell us about what's actually going to be on the road in 2035?

KEVIN KRAUSERT: It's super exciting to see this fast adoption of electric vehicles. You're seeing exponential growth in electric vehicles in all markets. Canada and the US are certainly lagging globally, with Europe and China vastly exceeding North American EV adoption rates.

But despite the fact that-- so, say, you have 100% sales of electric vehicles in 2035. If you're looking at it from forecasting demand destruction or potential demand destruction on oil, the number you should be looking at isn't actually EV adoption rates. The number you should be looking at is in internal combustion retirement rates.

And internal combustion retirement rates are actually happening a lot slower than you think, because there's a lot of people buying an electric vehicle and keeping their internal combustion vehicle as a secondary vehicle for when they need to travel to larger places, dealing with the range anxiety that exists in electric vehicles.

So it's almost the wrong number-- EV adoption rates is almost the wrong number to be looking at if you're actually looking at it from an oil demand viewpoint. But it's growing and it's going to require a tremendous increase in the electricity capacity of the country's grid and a whole bunch of other systems. I'm very excited about the future of EVs, but it's complicated-- it's more complicated than the politicians will have you believe.

JEFF LAGERQUIST: We are seeing all this government support for EV infrastructure. When do you think charging stations will no longer need this funding and be able to stand alone as businesses like gas stations do?

KEVIN KRAUSERT: I think that'll be a ways off. The reality is right now, electric vehicles on their lifecycle ownership costs are lower than internal combustion engines. However, the upfront capital costs are quite a bit higher.

And so the average Canadian with rising interest rates is probably as leveraged as they possibly can get. And so I don't see a lot of people being very-- having a strong appetite to take on an additional amount of debt to build out EV infrastructure, increase grid resilience, and have charging places all over the place.

So I think it's going to require government support. The energy transition is going to cost an absolute fortune. And I see technology is really being the best solution that we have to make this as affordable as possible. But we have to view this as a partnership between government, public, and shareholders. And I think if we can figure out what that partnership looks like, I think you'll start having some creative financial tools that could wean the government off of funding a lot of this.

JEFF LAGERQUIST: Yeah, absolutely. And there are private players, of course, who are very involved in charter networks: Petro-Canada, Shell Couche-Tard, Parkland. I believe they've all got some hands in that game. So yes, they're definitely there.

Moving on to a different element of EVs. Just yesterday, we saw a Belgian metals refiner announce a plan for a $1.5 billion factory in Ontario to produce EV components. It's supposed to be the first of its kind in North America.

Prime Minister Justin Trudeau says this is part of a big bet that Canada can be a key player in the electric vehicle supply chain. According to Bloomberg NEF, Canada ranks fifth globally on battery supply potential. We're behind China, the US, Germany, and Sweden. When it comes to actually getting these minerals and things like that out of the ground and doing the work, do you expect Canada will rank in that top five when it comes to actual production?

KEVIN KRAUSERT: If we get started. And I think it's also-- the same issue around some of these big energy transition projects is regulatory certainty, investor certainty. And that's what Canada needs to be focused on like a laser right now.

Yes, we've got some of the most pristine landscape in the world for rare Earth minerals and a lot of these critical minerals that are going to be required to drive this energy transition, but we've got to run a lot harder and a lot faster to meet this opportunity. But I think we'll get there.

And I also think that, again, a lot of the expertise in the mining sector of pulling lithium out of petroleum brines presents a new opportunity for lithium production, E3 metals. And Alberta here has just partnered with Imperial Oil for lithium production. So I see this as an exciting technology race. But again, we're going to need investor certainty from the government and we're going to need capital like we haven't seen it before.

JEFF LAGERQUIST: So just lastly, I'm fresh off of a long road trip, up to Ontario's cottage country. And that has certainly got me thinking about ditching the gas guzzling 07 Buick Sedan that my girlfriend inherited from her grandfather. Kevin, what do you drive and what would it take for you to go fully electric?

KEVIN KRAUSERT: [LAUGHS] I drive a 2014 Grand Cherokee that gets me out to the mountains. You get to the rigs. What would compel me to buy full electric would probably be not a two-year wait line.

Buying a car right now-- I was looking at getting a new car, and then I've heard it was like 18 months of wait and I'm so busy right now. So I think when supply chains catch up, and I don't have to wait two years, my next car will be probably at least a plug-in hybrid electric.

JEFF LAGERQUIST: That feels like a good place to end, Kevin. Thank you so much for joining me.

KEVIN KRAUSERT: Thanks so much for having me.

JEFF LAGERQUIST: For all the latest news on clean energy and the broader world of Canadian finance, please visit the Yahoo Finance Canada website. I'm Jeff Lagerquist. See you next time.

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