Over the last few years, I’ve been fairly consistently long energy stocks but the first few months of 2018 have left me wondering whether I’m missing something. Index firm S&P Dow Jones only yesterday put out a note looking at returns from its various European indices and surprise, surprise, the energy sector was in the dog house (although prize mutt was real estate). Over the 1 month to the end of February energy stocks within the S&P 350 Europe index were down -4.07%, whilst over the quarter to date that loss was slightly less at -3.53% – over the last 12 months, by contrast, energy stocks in Europe had notched up a gain of 7.86%. As you’d expect tech stocks have been the soar away success story of the last few months.
I find this all bit perplexing because energy businesses should be in good shape considering the chart below – it’s from Sharepad and shows prices for Brent over the last two years. In recent weeks prices have certainly edged backwards – as I write they are around $63 – but this is still well above where most people in the industry thought they’d be in 2018. Most of us expected oil prices to struggle to hit the top of the $40 to $60 range, whereas in recent months some have been wondering whether the new range is between $60 and $80.
In fact, back in mid-January equity analysts at Morgan Stanley – who, like me, have long favoured energy equities – observed that “Backwardation is a strong buy signal for oil & oil equities. The oil market has recently moved into backwardation, and analysis from our oils team suggests this is positive for both oil and oil equities. Our new oil price forecast of $75bbl by 3Q18 suggests the Energy sector could enjoy a 15-20% re-rating.” The chart below from Morgan Stanley (in mid-Jan) does most of the explaining required.
So, it’s against this backdrop that a note appeared in my email inbox earlier this week from Charles Ekins who runs a small firm called Ekins Guinness. He runs a multi ETF fund which uses his own asset allocation model pioneered many years back when he was CIO at ValuTrac. Combining technical and fundamental measures, Charles moves back and forth between different sectors, including energy. He observes that “the Oil & Gas Sector has underperformed against the UK market since early January (black line falling). This loss of relative momentum has caused our Model to go to a modest underweight again” – see his first chart below.
But Charles warns that this underweight position “ may only be temporary because relative Value Yield for the UK Oil & Gas Sector (blue line) is higher (i.e. more attractive) versus the UK market (red line), although the value premium is lower than previously. Note how the peak in early 2016 coincided with the start of major outperformance” – see his second chart below.
My own view – for what it’s worth – is that the oil price will be supported by the following factors in the near term:
- Strong global growth
- Strengthening growth rates in the oil-hungry developing world
- Signs of success for OPEC in its negotiations with the Russians to ‘manage’ the price of oil steadily higher
- US unconventional oil and gas is ramping up growth but not by quite the same quantum as in previous years.
Despite this near-term cautious optimism, I still think that come 2019 and beyond we could see oil prices slip (sharply) back into the $40 to $60 range, largely because of the Yanks and the money being thrown at their shale sector.
But in the meantime, we should be seeing the finances of many leading E&P and integrated energy majors strengthening, with increased dividends and cash earnings. This should be positive for profits, which makes me more bullish than ever about energy stocks.