BMO Optimistic About Alberta Economy, Energy Sector, Says CEO
Despite the gloom and doom in Alberta in response to the stalled Trans Mountain pipeline expansion, the head of one of Canada’s major banks sees a bright future for the provincial economy in which energy plays a major role.
“It doesn’t feel great when you remember where you were in 2010,” Darryl White, chief executive officer of BMO Financial, acknowledged in an interview during a recent visit to Calgary.
However, “you actually are at a place where you have affordable living, country-leading GDP growth, unemployment coming down in line with the rest of the country — it needs to go further for sure,” he said. “To me, those are proof points of a pivotal point in the cycle.”
BMO, said White, is bullish on the energy sector first and foremost because it thinks it has the best team in the business and it selects its clients and supports them over the long term.
From a financial services perspective, BMO is supporting industries that can help ultimately get Canadian natural resources to tidewater, creating jobs and employment for Canadians, he said. “You don’t have the ability, in my view, to maximize the potential of the Canadian economy if you do not support the sector.”
In addition, “we are constructive on the environment locally,” said the BMO chief executive. This year, GDP growth in Alberta is 2.4 per cent and it likely will be higher in 2019, White noted. “One of the things that I think people have lost perspective on is whether you’re in Alberta or outside Alberta, that’s leading the country.”
It’s also a “reasonable bet” that Alberta could lead economic growth in Canada next year with GDP of 2.5 per cent while the unemployment rate could drop to below six per cent, reflecting stronger oil prices and a more diversified economy. “If you get your unemployment rate down to 5.8 [per cent], 5.9 [per cent], you are in line with the rest of the country,” he said.
Shane Fildes, the Calgary-based managing director and head of BMO Capital Markets’ global energy group, shares that view.
“The consensus obviously is pretty bearish with the macro issues that we have had and some of the made-in-Canada problems . . . but we tend maybe to take a longer term view,” he said. “That longer term view is based on some of the fundamentals in the business and the fact that [the] supply demand balance fundamental is actually looking very, very strong.”
‘Great investment opportunity’
Although natural gas prices are still in the doldrums, the oil price has been quite strong and the free cash flow generation of some of the bank’s clients has never been higher as they are able to capitalize on the more efficient cost structure required to survive the downturn, according to Fildes. “Some of the smarter management teams are actually looking at it and saying ‘I have the ability to make more money today at $60 crude than I did at $140.”
Some of the larger companies with tens of billions of dollars of market cap could generate a quarter of their market cap in free cash flow over the next little while, he suggested. “That is a compelling investment piece.”
However, while BMO believes there’s a great investment opportunity, “it is going to take some intestinal fortitude of those investors to look through some of the near-term clouds for sure,” said Fildes.
“It’s a pretty rare day when you have in some cases all-time high cash flow generation and 20-year low valuations,” added White who once headed BMO Capital Markets. “That disconnect is remarkable but it does take courage.”
The question now is whether companies can maintain their cost discipline as activity picks up in response to higher oil prices. That’s why the market is so focused on return of capital, said Fildes who believes there is definitely some sustainable cost structure reduction due to the technology revolution. “It’s just a more efficient business.”
Industry consolidation on the horizon
The next step is some consolidation in the industry that actually takes out structural costs and that will be driven by the market’s requirement for a permanent sort of capital structure, cost structure reduction, he predicted. “It’s not exposed to inflation and we haven’t seen a lot of that but I think we are going to start to see some of that.”
There already has been some activity in the service sector such as Ensign Energy Service Inc.’s bid to take over Trinidad Drilling Ltd. and in the upstream sector, Surge Energy Inc.’s recent offer for Mount Bastion Oil & Gas Corp. in which BMO acted as an advisor to Surge.
“We haven’t seen a lot of transactions that have had a positive market reaction and I think when we see some rewards, if you will, you are going to start to see some more activity,” said Fildes. “From the strategic dialogue we are having with clients, it’s definitely happening in our view.”
And while he acknowledged that service companies aren’t getting the prices they believe they are entitled to, he believes that ultimately that industry activity will pick up. “We are starting to see some of the land based drillers have more utilization.”
The over-capacity that may exist in the pressure pumping part of the sector is “maybe a little problematic” but contract drillers are starting to do better which is behind recent M&A activity in the sector, said Fildes.
As a company, BMO has been in the oil and gas sector for a long time, principally in Calgary, and “our plan is to continue it for a long time,” said White.
“We have done it a very long time but we have invested heavily in this industry and the expertise and the solutions,” added Fildes who estimated that BMO Capital Markets has invested $40 billion to $50 billion in the energy upstream, midstream and downstream.
And while BMO Capital Markets thinks of its Calgary expertise with its 64 employees, it also has a very large office in Houston along with a London office. “We have invested in Asia, done a lot of cross-border work from Asia into North America.”
The company has put money into the various elements of the energy industry, including hiring geoscientists and developing a large acquisition/divestiture group. “But really it’s a geotechnical function that marries up with capital markets expertise,” he said. “We not only understand the capital flows of the business but we also understand the sub-surface issues that this business is so driven by. We have made the heavy lifting investment to be experts in the field.”
According to the company, BMO Capital Markets is a leading energy M&A advisor in Canada with more than $115 billion in transaction value since 2012.
Although the bank looks at the science and the technical aspects of the sector, it leads with advice and guidance and that model prevails wherever it does business, according to White. “The [lending] capital we have committed to the sector is the most important pool of capital that we have committed in the bank.”
BMO also has risk capital committed to the sector in terms of underwriting.
During the downturn, though, BMO’s credit losses in its energy book were the lowest among its peers, not only in Canada but from a North American perspective and “quite frankly were a de minimis [trivial] number from an absolute perspective,” said Fildes.
He attributed that to the company’s approach to the sector in its selection of clients, underwriting and risk management in the 2014 to 2016 period. “We back teams and clients we know have the expertise to make the hard decisions, that have the experience, when there’s a problem.”
“It’s one thing to have origination and underwriting expertise,” added White. “It’s another thing to have risk management expertise all the way through the cycle, for the benefit of the bank and the clients.”
BMO, in fact, grew its energy portfolio through the downturn, he said. “You might think the obvious thing would be to step back and tap the brakes but we actually grew the book through that period of time and we had the loss record performance that we had so we are pretty proud of that.”
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