We’re in the golden era of free cash flow for energy producers.

On Monday, we will see the launch of the Ninepoint Energy Income Fund. Portfolio manager Eric Nuttall suggests the time is more than right. We have the perfect backdrop, aside from the tragedy in Ukraine. We are in a golden era of free cash flow for Canadian and U.S. energy producers. It is the free cash flow that allows for generous dividends and robust dividend growth. The Ninepoint Energy Income Fund will also write covered calls delivering an income boost beyond the dividends.

I looked at the Ninepoint Energy Income Fund in last week’s Sunday Reads. I began that post with …

The energy sector has been the best-performing sector for well over a year now. In October of 2020 I suggested that readers give the energy sector another look, another chance perhaps. That suggestion was mostly based on the work of Eric Nuttall who runs the Ninepoint energy fund. From that October date the energy index (XEG) has delivered over 200%, while the Ninepoint fund has greatly eclipsed those returns.

My wife and I are invested in iShares XEG and the Ninepoint Energy ETF. The returns have been spectacular. This energy exposure is just one component of our inflation protection. We also hold commodities ETFs, plus gold and materials ETFs (XMA). In my RRSP account that commodities/energy exposure is near 10%. Other accounts have greater exposure. That said, the inflation protection has allowed the RRSP to reach new all-time highs. My Canadian bank, pipelines and telco holdings have also been performing very well.

There’s more that one way to build an all-weather balanced portfolio. One can use types of stocks in concert with ETFs to cover off the economic quadrants.

Backdrop – the golden era for energy stock dividends

According to Nuttall’s research and estimates, demand for oil will grow for 10 years or more. My research would also confirm this (unfortunate) energy reality. Oil supply will struggle to keep up with that demand. We are seeing the end of shale hypergrowth in the U.S. Add in the exhaustion of OPEC spare capacity. OPEC is missing production targets at every chance. In a recent presentation Nuttall offered …

The cupboards are bare. They will be called on and they won’t be there. That will be a big catalyst. 

And as I offered in this week’s Making Sense of the Markets, the tragic events in Ukraine are inflationary for oil and gas. In fact, the situation is inflationary for agriculture, metals and more.

Lack of investment

We have seen insufficient investment in new oil projects, from 2014. Politics and public policy has made it difficult to invest in oil and gas exploration. It takes 5 to 7 years to get a major oil project up and running.

Fortunately for many of the Canadian oil producers, they have put in the capex (capital expenditures) and are sitting on 10 to 15 years of reserves. They can largely pump and print and deliver those cash flow gushers leading to generous and growing dividends.

Nuttall offers that the free cash flow yield is ridiculous – – 23% on average for the sector. If companies return 50% of the free cash flow yield by way of dividends, that equates to a 11.5% dividend yield. That is based on an $80 oil price. That is the potential for the dividend, but no company will stretch to their full potential of dividend payout.

Goodbye debt

The oil producers don’t need the banks. At current free cash flow yields, the average producer can retire all debt and buy back all shares in about 3.5 years.

The covered call booster

The Ninepoint Energy Income Fund will also write covered calls that will add an additional income boost. Nuttall aims to use his sector expertise to add a volatility premium. Obviously the sector is incredibly volatile and that can provide opportunity when an investor is writing calls. The sector might offer up higher premiums than average. The energy sector is terribly inefficient and Nuttall will aim to take advantage. 

The covered call strategy might be able to add an additional 3% to the annual yield. Nuttall offers that the fund will begin at a 5% initial yield with the hope of ramping up from there. He wants to walk before he runs.

Just arrived, the 40% income boost

On Aug. 25, 2022, Ninepoint Partners announced a significant increase in the monthly distribution, increasing the annual target by 40%, from 5% to 7% effective the August distribution. There may be more to come on that front.

Eric reports that …

Things are working out, even more than expected.

The backdrop suggests that the fund could deliver well beyond that rate (even) if oil prices settle in the $60-$70 range. Nuttall offers that the dividends should be well protected at $60 oil. 

I have a modest position in the Ninepoint Energy Income ETF (NRGI). I harvested very generous profits in our oil and gas ETFs and moved to an energy dividend approach. The fund works in concert with several energy stocks.

The Ninepoint Energy Income fund

While the Ninepoint Energy Fund invests in mid and small cap energy producers (seeking the greatest total returns), the income fund will invest in larger companies.

The mix will be in the area of 60% Canadian companies and 40% U.S. companies. 17% of the holdings will be pipelines.

The mutual funds and ETF will be available on March 7th.

Big fees on Cut The Crap Investing?

When I tweeted my original post I took some heat for ‘suggesting’ a high fee fund. Of course, the posts are not a recommendation. You can read and decide. In rare cases I am happy to pay some higher fees for expertise. The Ninepoint Energy ETF has those high fees but it is the best-performing energy fund on the planet. And it has destroyed the energy index in Canada.

With the Ninepoint Energy Income Fund we are paying Nuttall for his sector expertise and covered call writing. You may decide to go your own route and buy a bunch of generous Canadian and U.S. energy companies. You many know how to write calls.

You might also have a look at the CI Energy Giants covered call ETF.

Total return to energy income transition

I will continue to hold XEG and the Ninepoint Energy ETF. Over the next year I will trim some of those total returns (should they continue to arrive) and I will move those proceeds to the income fund. I will also add some individual dividend paying stocks starting with Canadian Natural Resources (CNQ), Suncor (SU) and a few others.

Energy can provide a nice inflation hedge. In fact it’s the only sector that consistently worked during periods of rising inflation and stagflation. The energy income and total returns will work in concert with our gold, commodities and real estate exposure.

To have meaningful inflation protection you might need (commodities) exposure in the 20% range. But of course, very few investors want to hold an asset class that can do nothing for a decade or more. That it the essence of portfolio insurance, there can be a cost. But when you need it, you are more than happy to have that holding, and protection.

A little perspective on the #commodity runup.
1 – It has been a long losing trade since the financial crisis.
2 – Spikes in commodity prices tend to precede contractions. pic.twitter.com/WffoyfuwkE

— Lance Roberts (@LanceRoberts) March 3, 2022

Given that we take an all-weather approach, our portfolios are at or near all-time highs.

Related post: Using ETFs for fund retirement.

Thanks for reading. We’ll see you in the comment section. Do you like the sound of some energy income?

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