Cheap oil no reason to abandon the energy sector, strategists say

Oil at $100 a barrel might be a thing of the past for now, but there are a lot of companies in the exploration and production business that are well positioned for the future

Dec 3, 2014 @ 1:25 pm

By Jeff Benjamin

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Falling crude oil prices are leaving more money in consumers' pockets just in time for the holidays, but at least one analyst believes the selloff in energy companies may be overdone.

“The clear winners are the users of oil, which is pretty much every sector, but especially technology, consumer discretionary, and manufacturing,” said Douglas Coté, chief investment strategist at Voya Financial Inc.

“I think consumers are the big story that is being missed right now,” he added.

Even the energy sector, which has suffered the most over the past several months as the price of oil has dropped from $81 a barrel on Oct. 30 to $67, is now seen as an investment opportunity.

Over the past three months, the energy sector of the S&P 500 Index has declined by 14.6%, while the S&P has gained 3.5%.

Since the start of the year, the S&P has gained 12%, while the energy sector has lost 7%.

Mr. Coté believes that the pullback is already overdone, and that the innovation potential in the energy space makes attractive values for many of the companies in that sector.

“Energy companies are being punished, but a contrarian would say maybe it's overdone,” he said. “If I'm buying equities right now, I'm buying energy companies. Because U.S. corporations have tons of cash, they're very resilient and very astute. Remember, it's the U.S. energy companies that created the revolution of fracking that they're now being hurt by.”

Stewart Glickman, group head of energy research at S&P Capital IQ, said even as several energy companies have seen share prices fall in stride with oil prices, to completely abandon the sector is to ignore the potential for innovation and adaptability.

While oil at $100 a barrel might be a thing of the past for now, there are a lot of companies in the exploration and production business that are well positioned with solid balance sheets and diversified business lines.

Among the companies he listed as likely to fare well even in a weak oil price environment: EOG Resources (EOG), Devon Energy (DVN), ConocoPhillips (COP), and Occidental Petroleum (OXY).

For those investors looking to take on a bit more risk in the energy space, Mr. Glickman listed Pioneer Natural Resources (PXXD), Energen Corp. (EGN) and Bill Barrett Corp. (BBG).

“Keep in mind, for this latter subset, weak oil prices can be mitigated if these companies had the good foresight to hedge out future production in recent months,” Mr. Glickman explained.

For those investors looking for a more diversified approach to the energy sector, Mr. Glickman recommends iShares US Energy ETF (IYE) and Fidelity MSCI Energy Index ETF (FENY).

Jeff Tjornehoj, head of Americas research for Lipper Inc., concurs that investors should not overlook the renowned resilience of the U.S. energy industry.

“They've been through this kind of cycle before, he said. “I recall the late '90s when oil crashed to $12 a barrel. There definitely will be some victims of low oil prices, and it will probably affect some of the junior oil operators more, but the big ones won't run out of money.”

At least when it comes to domestic natural resource mutual funds, that message seems to be taking hold.

Looking at the period of the most active recent oil-price movements since mid-July, Mr. Tjornehoj found that domestic natural resource mutual funds have experienced mostly inflows, despite mostly negative performance.

The category average performance from July 16 through the end of November was a decline of 2.2%, and it saw total net outflows of $137 million, with most weeks generating net inflows over the period.

The declining performance dragged total assets down to $10.3 billion from $12.4 billion over the 20-week period during which the S&P 500 gained 5.2%

The largest funds in the domestic energy category are the $2.2 billion Fidelity Select Energy Portfolio (FSNEX), which is down 11.2% so far this year, and the $900 million Fidelity Select Energy Service Portfolio (FSESX), which is down 21% this year.

Among global energy funds, the story is more extreme both in terms of performance and outflows.

Over the same period from mid-July, the category has shrunk to $35 billion from $43 billion, and has generated an average decline of 21.3%.

Of the largest funds in the category, the $11.7 billion Vanguard Energy Fund (VGELX) is down 10.7% this year, and the $4.2 billion T. Rowe New Era Fund (PRENX) is down 6.4%.

In terms of exchange traded funds, the largest fund is the $10.7 billion Energy Select Sector (XLE), which is down 8.5% this year.

As Mr. Coté emphasized, the market is currently responding to the immediate drop in oil prices and missing the bigger picture of the kind of innovation that got us here in the first place.

“The energy industry created this tectonic shift, and you shouldn't count it out or ignore its ability to adapt,” he said. “The energy game is now busted because of the technological revolution, and the days of $80-to-$100 oil are over.”

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