Oil drills

Five reasons to choose energy in 2017

January 18, 2017
Ivy Energy Fund

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Story Highlights

  • We think OPEC has set an oil price floor at about $50 per barrel.
  • Oil has flipped to undersupply from oversupply.
  • Potential for energy sector likely to continue

The Organization of Petroleum Exporting Countries (OPEC) in November 2016 agreed to reduce crude oil production quotas by 1.2 million barrels per day (bpd) — the first cut in eight years. OPEC set the new target at 32.5 million bpd, which translates to a meaningful reduction in supply.Percentile Rankings for Ivy Energy We think OPEC’s action effectively set a floor for oil prices at about $50 per barrel.

Government balance sheets in OPEC-member countries rely heavily on income from oil production. OPEC’s concern two years ago was protection of its market share — which drove prices down. But member states across OPEC now are seeking higher prices and a boost in oil revenues, which have suffered because of ongoing low crude oil prices. In addition, Saudi Arabia’s state oil company, Saudi Aramco, has announced it intends to go public, probably in 2018. Higher oil prices are likely to help the pricing of a Saudi Aramco public offering.


We think there are five key ideas to keep in mind as we enter 2017.

  1. Oil has flipped to undersupply from oversupply
  2. The sharp move down in prices that began in November 2014 was driven by a peak oversupply of about 2% of global production. It’s worth noting that such an oversupply equals less than 30 minutes of global demand and is a much smaller oversupply than in prior oil price cycles. Given production cuts globally from uneconomical projects and the forecast for 2017 global oil demand growth of 1.2 million bpd — on top of the current total of 95 million bpd – we believe the market was approximately in balance before the OPEC announcement. Assuming even partial participation in OPEC production cuts, we now think the world faces a supply deficit and inventories will continue to fall in the coming months.

  3. We see few downside risks to crude oil prices
  4. We think it’s unlikely that oil will fall below the $50 floor for any prolonged period. Such a move would require a worldwide recession with a significant decline in demand, and we do not think recession is likely. A complete disregard by OPEC members of the production quota decision also could cause prices to fall in the short term, but again we think that is unlikely. Even if OPEC were to lift its new limits, we believe the oil market was in balance prior to the quota decision. In our view, OPEC’s output cut simply prompted a short-term, sharp move higher in prices and will cause existing inventories to be drawn down more quickly than they otherwise may have been.

    We believe oil market fundamentals still are strong and demand growth remains consistently positive. We think inventories will return to regular levels by mid-2017 and would have done so even without OPEC’s intervention.

  5. Potential for energy sector likely to continue
  6. Those who invested in many energy stocks in 2016 had the opportunity to benefit as the year progressed. For example, Ivy Energy Fund increased 59.7% from Feb. 11 — the date West Texas Intermediate (WTI) crude oil hit its low for the year of $26.19 per barrel — through Dec. 31, 2016.1 We believe there still are potential opportunities in 2017 in the energy sector, especially when compared to other market sectors. Based on our market analysis, we think WTI crude oil — the U.S. benchmark for the physical commodity — could reach the mid to high $60s per barrel this year, compared with about $53 as 2016 came to a close. This would represent price appreciation of about 30% in 2017.

    In our view, the steady growth in global oil demand means energy companies will need to make new investments to meet supply requirements, and higher oil prices are needed to attract new investment. In addition, the industry will need time to get spending going, hire workers and resume or initiate projects. Oil industry capital spending was cut by 50% in the last two years and employment was drastically reduced. We believe these factors mean output will be slow to recover versus the stable demand growth worldwide.

  7. Taking the long view: 2018 and beyond
  8. Some in the marketplace have been concerned that higher oil prices will cause an immediate ramp-up in U.S. onshore oil production, which in turn will put a ceiling on oil prices. We do not believe this scenario is likely.

    Consider the initial boom in U.S. shale oil production. During the five-year period that saw the largest production growth for U.S. shale regions, we estimate that approximately $400-500 billion was spent developingthose plays. That investment increased U.S. production by a little less than 5 million bpd and increasing oil prices sustained companies’ ongoing investment. Similarly, for production to expand over a multi-year period, higher oil prices will be required now. If prices falter, supplies will once again come offline. The magnitude of investment required to significantly increase production also does not happen overnight. OPEC’s excess production capacity also is a factor because it is at a multi-decade low. It totaled 16 million bpd on global consumption of 58 million in 1983, but now is only 1 million bpd on consumption of 95 million.

    Critically, because of low prices, projects were postponed in such a way that many which had been set to come on in 2018 may not be online until 2020 or later, potentially creating a supply gap. U.S. shale oil production can help fill the gap, but we do not believe production here can ramp up quickly enough to make up for both growing global demand and declining production from existing wells globally. In addition, discoveries of new oil reserves totaled 2.8 billion barrels worldwide in 2015, the lowest annual volume since 1954.2 We believe the supply/demand situation overall bodes well for oil prices in the long term.

  9. Ivy Energy Fund’s performance when oil prices have risen
  10. The Fund has performed well compared with its peer group during periods when oil prices have risen. Eight times since the Fund’s inception, WTI crude oil experienced a rise of 15% or more from trough to peak. In seven of those eight periods, the Fund outperformed its Morningstar peer category average. In all periods, the Fund outperformed its benchmark index, the S&P 1500 Energy Index.

    Because the Fund historically has been underweight versus the benchmark in integrated oil & gas companies — or “oil majors” — it typically has outperformed when oil prices have risen. Integrated companies often pay dividends, rather than focus on growth, which is one reason they are viewed as a defensive play in the energy sector. Investors thus may unintentionally take a more defensive position than desired during a rising market by investing in passive funds that mirror a benchmark.

    We still advocate our company-specific exposure in a variety of industries within the energy sector and believe the Fund remains well positioned if oil prices move into the downward part of the cycle — which we do not anticipate in the near term.

Ivy Energy Fund has shined relative to peer group when oil prices have risen (Cumulative percentage return in each period)

Sources: U.S. Energy Administration, Morningstar Direct. Trough to peak periods where West Texas Intermediate (WTI) Crude Oil, the benchmark for U.S. crude oil prices, advanced more than 15% since Ivy Energy Fund's inception. The S&P 1500 Energy Sector Index represents companies in the energy sector of the stock market. The Morningstar Equity Energy Category includes portfolios that invest primarily in equity securities of U.S. or non-U.S. companies that conduct business primarily in energy-related industries.

 
Fund performance – Average Annual Total Returns (%)

Data quoted is past performance and current performance may be lower or higher. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. Please visit www.ivyinvestments.com for the Fund’s most recent month-end performance. Class A share performance, including sales charges, reflects the maximum applicable front-end sales load of 5.75%. Performance at net asset value (NAV) does not include the effect of sales charts. If it had, the performance shown would have been lower.



1
Source: Ivy Energy Fund, Class A (NAV); West Texas Intermediate crude oil price, U.S. Energy Information Administration

2Source: Financial Times, “Oil discoveries slump to 60-year low,” May 8, 2016


Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through January 2017, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.

Risk factors: 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.

Percentile rank is total-return percentile rank relative to all funds in the category. The highest (or most favorable) percentile rank is 1 and the lowest (or least favorable) percentile rank is 100. The top-performing fund in a category will always receive a rank of 1. Percentile rank is based on total returns which include reinvested dividends and capital gains, if any, and exclude sales charges.

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