Oil prices and industry feel impact of U.S. shale basins
- We believe the international market remains relatively balanced and should support oil prices of $105-$115 per barrel.
- We think it is unlikely the U.S. will allow producers to begin crude oil exports this year.
- We believe energy companies are likely to continue to benefit from improving fundamentals.
Global oil and gas production continues to increase, as does demand. In the U.S., there has been particularly dramatic growth in oil output from shale basins, which is affecting companies across the energy industry. Portfolio Manager David Ginther offers his latest views on production, oil prices and several key Fund holdings.
The oil price differential and outlook
We believe the international market remains relatively balanced and should support oil prices in the $105-$115 per barrel range. We also think there is a “floor” for the West Texas Intermediate (WTI) oil price around a level at which exploration & production (E&P) companies would need to cut capital expenditures significantly. We estimate that price is $75 to $85 per barrel. In our view, it is unlikely the U.S. government will allow producers in this country to begin crude oil exports this year.
We think the price difference in crude oil between Brent and WTI – the two key price benchmarks – will remain wide, averaging $7-$10 per barrel. We also believe it will be volatile, depending on the time of year. The differential has begun to widen since the start of 2014 and we believe it may widen even more in the second half of the year. This mainly is because of strong production growth in the U.S., which we think will lead to growing inventory. Refiners are operating at high capacity-utilization levels and most imports of light crude oil have been displaced by domestic production. This means domestic light production may start competing with imports of medium crude (which is priced lower) for space in refineries.
In our view, energy companies are likely to continue to benefit from improving fundamentals, which in turn can lead to higher margins and returns:
- Service companies are seeing rising volume and pricing;
- Selected exploration and production (E&P) companies are seeing strong production growth and productivity;
- Refiners generally are benefitting from wide differentials;
- Midstream companies are seeing strong growth from the need to build infrastructure;
- Integrated oil companies are starting to see improved returns through reductions in capital expenditures.
E&P in a time of production growth
We analyze E&P companies on an individual basis, not as a group. However, we must consider the price of oil when making an evaluation because it is a very important variable in analyzing any of these companies.
Given the strong ramp-up in U.S. production and the impact from shale basins, we think crude oil prices are not likely to be a supporting factor for E&P companies in the near term and could be a significant headwind at some point. In addition, the oil services market is beginning to tighten, which could lead to higher costs for E&P companies.
By contrast, many E&P companies are benefitting from significant gains in productivity. When drilling wells, greater productivity has two positive effects: increased volume and lower unit costs. If productivity improvements are strong enough, they could allow an E&P company to overcome lower commodity prices and higher service costs. In making selections for the Fund, we look for companies with increasing productivity in the E&P group because we think it potentially may lead to superior growth, increasing margins and increasing return on capital.
Fund holdings illustrate our views
Halliburton/HAL: Halliburton dominates the North American market for oil service, which is where the strongest growth is for oil/gas production. Shale gas and oil have been the huge growth drivers, and we think HAL is the best company in that market, set apart by its ability to provide high-quality service, technology and logistics management. The stock typically has traded at a discount to its closest peer firms yet has had superior growth and similar return on capital.
EOG Resources, Inc./EOG: EOG Resources is an E&P focused on shale regions in the U.S., Canada and China, as well as offshore areas near Trinidad and the U.K. It was an early mover in acquiring desirable acreage in the Eagle Ford and Bakken shale areas. By accessing these high-growth areas early on, EOG has become the largest U.S. onshore crude oil producer. Sand is an integral part of the hydraulic fracturing process, or “fracking,” and demand for quality sand is high. To control costs and create a more reliable supply chain for such sand, EOG owns mines and processing facilities in Wisconsin and Texas.
Noble Energy/NBL: We think Noble Energy has one of the highest quality management teams in E&P and one of the best multi-year growth stories in the group. The company is well-diversified between oil/gas and domestic/international, preventing NBL from being overly exposed to poor pricing in one area. It has shown the ability to grow profitably over several years, which has been rare in E&P.
Phillips 66/PSX: While refining has historically not been a great business in the U.S., we think the group is in a multi-year phase of strong profits and cash flow. We think it is being driven by the gap in domestic oil/gas pricing versus international pricing, which allows U.S. refiners to have lower input costs than international refiners and higher profits. As long as U.S. production of oil/gas continues to grow rapidly and U.S. policy continues to ban oil exports, we think U.S. refiners will do well.
PSX is focused on the long term, putting excess cash generated from refining into higher return businesses such as midstream processing of petroleum as well as chemicals.
Canadian Pacific Railway Ltd./CP: Canadian Pacific highlights the Fund’s ability to invest in companies not specifically operating in energy but inextricably tied to the industry. CP has experienced significant growth from its access to the Bakken and Marcellus shale formations. It is the only rail carrier with single-line access from the Bakken to the northeast U.S. CP carries sand, pipe and other materials for oil and gas wells, as well as crude oil to refineries. It has had a significant gain in traffic from the energy renaissance in North America.
|Core Laboratories NV
|Baker Hughes, Inc.
|Cabot Oil & Gas Corp.
|Southwestern Energy Co.
|EOG Resources, Inc.
|Weatherford International Ltd.
|Noble Energy, Inc.
Past performance is no guarantee of future results.The opinions expressed are those of the Fund’s portfolio manager and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through May 30, 2014, and are subject to change due to market conditions or other factors.
Investment return and principal value will fluctuate, and it is possible to lose money by investing.
Risk factors. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. Investing in the energy sector can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments, and the cost assumed by energy companies in complying with environmental safety regulations.These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.