Caisse Warns on Canada's Energy Policy?

CBC News recently reported, Caisse CEO sees energy policy challenge ahead for Canada:
Energy policy is the single biggest issue facing Canada, according to Michael Sabia, head of one of Canada’s largest pension funds.

The Caisse de dépôt et placement du Québec is a major investor in the energy sector and energy infrastructure.

But Caisse CEO Sabia foresees significant change in the energy sector because of the energy revolution in the U.S. caused by massive tapping of shale oil and gas.

That shale oil revolution is partly responsible for the recent glut of oil worldwide, which has driven oil prices to the $80 a barrel level.

Mexico has also restructured its oil sector, making it more open to foreign investment.

“All of these things can very much change how the Canadian energy industry itself works. So that is an issue that we’re very focused on, because we are a large energy investor on a global basis,” Sabia said in an interview with CBC’s The Exchange with Amanda Lang.

Sabia said the Caisse is a big investor in both traditional sources of energy and renewable energy. But right now, pipelines are of particular interest, he said.
Realignment required

“We think that particularly in North America, there is such an important realignment of energy infrastructure that’s required, given what’s happened in the United States and what may happen in Mexico, that there should be some very interesting pipeline or infrastructure opportunities in the energy business,” he said.

Canada faces some difficult issues on the energy file, including who will buy our oil and gas as the U.S. becomes more energy self-sufficient and world oil prices fall.

“I think the issue facing Canada is, how do we market it, how do we move that energy into markets where it can be consumed?” Sabia said.

“Some of that will always be in the United States. But in the past we’ve relied very heavily on the United States. Will that be sufficient going forward, given what’s happened in that country? Open question. Therefore, moving energy east-west is important.”

The Caisse had just under $215 billion under management as of June 2014, including public pension and insurance assets.

Sabia said the Caisse sees future investment potential in Australia, but also mentions Mexico as an area of interest.

“We think that country may be on the brink of really some breakout levels of economic growth which could present us with some very interesting opportunities,” he said.

He’s acutely aware of the signs of a world global slowdown which means taking great care in selecting investment opportunities, and looking to the long term. He also seeks out regional partners who can open doors.

“What that [slow growth] means for us is not that there are no opportunities — there are opportunities — but it requires a particular approach to how we go about investing,” Sabia said.

“It requires us to place...a great deal of emphasis on the quality of our research, on deep, deep asset-specific research. I think the key word in these kinds of markets and in this kind of global situation is to be highly selective. This is not a time to be buying indices, or buying broadly asset classes, this is about asset by asset selection.”
Jack Bogle, the founder of the Vanguard Group, the world’s largest investment company, totally disagrees with that last statement, but he's selling his approach and low-cost index funds.

It's highly unusual for the head of a major Canadian public pension fund, let alone the head of Quebec's public pension fund, to come out warning on Canada's energy policy, but not without precedent.

Go back to read my comment on why it's time to short Canada, which I wrote last December and where I quoted an article on Leo de Bever warning that oil prices will drop to $70 US per barrel or lower over the next five years:
“If (WTI prices) go to $70 (US) a barrel, that’s a problem for Alberta, and the risks (of that happening) are pretty high,” de Bever said. “If this province is going to advance it has to deal with some of this. If we can bring the cost of refining down so we’re no longer the high-cost producer, we might give ourselves some options of not just shipping it to the Gulf but maybe refining more up here and shipping the high value-added stuff.”

In particular, AIMCo is trying to identify technologies that would use less energy to convert raw bitumen into synthetic crude.
Leo's prediction came a lot faster than he thought and despite the recent plunge, I think oil prices are heading a lot lower, which doesn't augur well for Alberta or Canada (keep shorting the loonie!).

And the problem with oil isn't just an oversupply story. As I keep warning my readers, too many investors are underestimating the "new" risk of deflation emanating from the eurozone and possibly spreading to North America. The surge in the mighty greenback is also weighing on commodity prices but that too is a byproduct of the euro deflation crisis, which is a demand driven story.

Now, getting back to the article above, Sabia specifically mentions Mexico as an area of interest for the Caisse. Reuters recently published a story on how the Caisse is set to unveil a big Mexico infrastructure fund:
Canada's second-largest pension fund, Caisse de depot et placement du Québec, is set to make a big foray into Mexico following an initial $100 million investment in real estate, according to two sources familiar with the matter.

The sources, who requested not to be named as the deal is not yet public, said the Quebec fund is poised to soon unveil a large infrastructure-related investment in the Latin American country.

One source said Caisse and a Mexican institutional investor plan to create a joint fund to invest up to several billion dollars in domestic infrastructure projects. A deal is likely to be finalized soon, the source said.

A Caisse spokesman declined to comment on the matter.

The planned infrastructure fund comes on the heels of a Mexico City investment last week by the Caisse's real estate arm Ivanhoé Cambridge.

The deals underscore the growing global ambitions of the Caisse, which had C$294.5 billion ($260.7 billion) in assets under management as of Dec. 31, 2013, and manages pension and insurance funds in the Canadian province of Québec.

It also comes as large projects promised by Mexico President Enrique Pena Nieto, who has spent his first two years in office passing numerous economic reforms, move closer to getting under way.

These projects include high-speed passenger rail from Mexico City to Queretaro, a new $9 billion airport in the capital and a $10 billion national broadband network. An impending spin-off of thousands of telecom towers owned by Carlos Slim's America Movil (AMXL.MX: Quote) could also present an investment opportunity.

Caisse Chief Executive Michael Sabia is very familiar with the telecom sector, having run BCE (BCE.TO: Quote), Canada's largest telecom company for six years before moving on to head the pension fund manager in 2009, after the global financial crisis.

The fund lost C$39.8 billion in 2008, due in part to risky real estate bets, and saw its net asset base drop to about C$120 billion. It has since been on a surer footing, with net assets recovering to nearly C$215 billion as of June 30.

In June, Sabia said the Caisse, which has long focused on investments in companies and projects within Québec, would increasingly be looking for opportunities abroad.

The fund planned to expand its investing teams and work with new partners, he said, adding it would open an office in Mexico and Singapore, as part of a plan to boost investments in Latin America and Asia.

"It is our responsibility to go out and seek returns where they are," said Sabia. "This will be one of the cornerstones of everything we do over the next five years."

The overseas bets would mirror those of its larger rival, the Canada Pension Plan Investment Board (CPPIB), which has been actively investing funds in infrastructure, real estate and logistics assets overseas in the last few years.

Caisse, CPPIB and rival pension funds and sovereign wealth funds, are all scouting for long-life revenue generating assets. The firms have been making significant bets in physical assets like farmland and forests, along with investments in ports, real estate, hydro-electric power projects and other such assets.

Ivanhoé Cambridge, Caisse's real estate arm, announced last week that it plans to make its first direct investment in Mexico, with an initial investment of more than $100 million in a project in Mexico City. Ivanhoé Cambridge, which has some $40 billion in assets, will spend up to $500 million on its Mexican venture.
Ivanhoé Cambridge's first direct investment in Mexico will be in the development of mixed-use urban communities in Mexico:
It will invest primarily in the cities of Mexico City, Monterrey and Guadalajara and has partnered with Black Creek Group, a real estate private equity firm with extensive experience sponsoring real estate companies in the country.

Ivanhoé Cambridge’s first investment of more than US$100 million will be used for a residential development project located in the Mexico City borough of Cuajimalpa, adjacent to the Santa Fe business district.

The project consists of two residential condominium buildings comprising 479 residential units.

“With this investment, Ivanhoé Cambridge is setting a major foothold in Mexico, which will provide excellent access to opportunities, including long-term investments in a portfolio of high-quality assets,” says Rita-Rose Gagné, executive vice-president, growth markets, with Ivanhoé Cambridge.

“The investment is part of Ivanhoé Cambridge’s strategy of developing a long-term, active presence in growth markets,” she adds. “The economic growth and demographic trends in Mexico are producing a large and sustained local demand for commercial and residential real estate.”
Now, Mexico is a country with huge potential but it also has major pitfalls too. It's riddled with crime and corruption and the recent case of the savage massacre of Mexican students has sparked protests and cast a very dark shadow over the country.

Mexico's oil reforms could trigger a major economic boom but as I recently discussed in my comment on CPPIB's risky bet on Brazil, Latin American economies are vulnerable to a major crisis right now and investing in their public and private markets is fraught with risks. Furthermore, investing in Mexico and Australia is highly correlated to the Canadian market.

But I also stated these are very long-term investments which is why the Caisse and CPPIB are going ahead with them, seemingly oblivious to any short-term crisis that might develop in these countries.

It's also worth noting the Caisse pulled out of Mexico and many other countries in 2002 after Henri-Paul Rousseau took over the helm, but are now looking to get back in there. Is this a good move? Who knows? There are strong arguments to be made for and against these ambitious investments in foreign countries.

But I agree with Michael Sabia, Canada's energy policy needs to be revamped to reflect major structural changes going on in the global economy.  He's also right that there will be very interesting opportunities in pipelines which are somewhat insulated from the decline in oil prices.

Interestingly, shares of Enbridge (ENB) and TransCanada Corp. (TRP) have recovered from the recent selloff and so have shares of U.S. pipeline companies like Energy Transfer Partners (ETP) and Kinder Morgan Energy Partners (KMP). These pipeline companies pay out nice dividends but they make me nervous so I wouldn't be overweighting my portfolio with them (after doing well for many years, they're vulnerable to sharp declines).

Take the time to listen to Michael Sabia's interview with CBC’s The Exchange with Amanda Lang. You can click here to listen to it. For some annoying reason, the CBC doesn't share the embed code on its video clips anymore, which is the stupidest thing you can do in the age of social media (the Caisse and other public pension funds should be providing all of their senior managers' interviews on their website with an embed code just like Ontario Teachers and HOOPP do).

Below, MoneyTalk's Kim Parlee sits down with Bill Priest, CEO and Co-CIO of New York-based Epoch Investment Partners, to talk about global growth, debt, and deflation. You should also watch another interview Ms. Parlee conducted with Bill Priest in September which is posted on Epoch's website. Very smart man and you should listen carefully to his comments.

I also embedded a clip from GaveKal Capital’s Eric Bush who takes a look at what’s driving the energy sector’s seemingly compelling valuations. If you’re considering buying energy stocks, check out this analysis first.

I agree with his comments and others who think investors betting on a mean reversion in energy are going to get their heads handed to them.