The US-Israel–Iran war has created another oil shock by disrupting trade on the Strait of Hormuz, which handles roughly 25% of all seaborne oil worldwide. While there is ample demand and supply, the logistics are just not right. The war in Iran has escalated tensions in the entire Middle East, which accounts for 40% of global oil shipments, and disrupted the global balance. The supply shock drove up the Brent crude price above US$100/barrel.
Rising oil prices affect almost all industries and drive up inflation as logistics become expensive. The best way to counter oil price-induced inflation is to invest in stocks that benefit from rising oil prices.
The correlation between Brent Crude and WTI
The US-produced Brent Crude price surged 77%, and the Canada-exported West Texas Intermediate (WTI) price jumped 70%. This 10% gap reflects the US tariff on Canadian oil imports. If you are wondering about the correlation between WTI and Brent crude, it’s the mismatch in light Brent crude of the US and the heavy WTI oil refining capacity of US refineries.
The next is logistics cost. Transmitting oil from Texas to the East Coast will be expensive, as American crewed vessels will transmit the oil. America can simply import oil from Saudi Arabia at a lower cost. So while America can produce the oil it needs, it cannot use it. Thus, it relies on imported oil for use and exports its own oil to North America, Asia, and Europe. Any change in Brent crude price also affects WTI.
Three TSX Stocks that benefit from every dollar it climbs
Oil companies benefit from rising oil prices as they can charge a higher price for their product. This helps them generate excess funds flow, which they channel towards increasing production capacity, repaying debt, and distributing dividends.
Canadian oil stocks Suncor Energy (TSX:SU) and Cenovus Energy (TSX:CVE) jumped 34% and 36%, respectively, year-to-date, as WTI surged 70%. Suncor and Cenovus are integrated oil companies, carrying out both upstream and downstream operations. It means they extract, refine, and market crude oil, natural gas, and refined petroleum products. A US$1/barrel increase in WTI increases their adjusted funds from operations (AFFO) by $215 million and $220 million, respectively.
| Change in Adjusted Funds Flow | US$1/bbl | 0.01 Forex (US$/C$) |
| Suncor Energy | $215 Million | $270 Million |
| Freehold Royalties | $3.9 Million | $3.1 Million |
| Cenovus Energy | $220 Million | $170 Million |
Both stocks have sustained their base dividend at US$50 WTI, which means they can continue to pay existing dividends if the WTI falls. They have achieved this target by reducing their breakeven cost through operating efficiency and technology. Suncor reduced its WTI breakeven by US$10/bbl. Cenovus achieved the lowest combined sustaining + operating costs of ~US$21/bbl.
They also maintained strong financial discipline. They used the past three-year upcycle to reduce net debt to 1 times its AFFO at US$50 WTI.
Why US$50? This is the normalized WTI price after the 2014 US shale oil boom. As the oil price fell, companies had to adjust to the new normal by pausing expansion, increasing capacity utilization, and lowering debt. Thus, debt is relative to the AFFO, which is directly affected by the oil price.
Cenovus plans to use excess AFFO from higher oil prices to reduce net debt from $8.3 billion to $4 billion in the long term.
Freehold Royalties
Freehold Royalties (TSX:FRU) is another stock that is sensitive to oil prices as its royalty payments depend on them. Freehold owns lands in the Pembina basin in the United States and several oil sands reserves in Canada. Pembina helps it earn a premium price due to its premium light oil and proximity to the Gulf Coast.
Every US$1/bbl increase in WTI increases Freehold AFFO by $3.9 million. Freehold does not have any operational risk as it leases the land to oil companies. It has maintained its net debt at 1.1 times its AFFO and can sustain its current dividend at US$50 WTI.
The three stocks will rise with the oil price and also grow dividends in an upcycle.
