For energy investors looking to boost their portfolios for 2014, key factors to consider are the global balance of demand and supply, and the price of energy commodities.
Out of Favour
Most experts agree that the energy sector has been floundering and has been out of favour for nearly two years.
“The global energy sector has been underperforming for the past 34 months. The evaluation of energy equities are at a 30-40% discount to global stock markets,” according to Jonathan Waghorn, portfolio manager at Guinness Asset Management.
In the global oil sector there is concern that the oil price will plummet. Analyst forecasts of the forward curve signal that prices are going downhill due to an oversupply of oil relative to demand. Similarly, the natural gas sector has been underperforming the past 3-4 years, and gas prices have gone down somewhat. Additionally, there is some alarm that the US gas market will continue to be a low price environment.
UK opportunists
Domestic concerns in the UK such as higher consumer prices, regulation crack-down and alleged price rigging of wholesale commodities splashed across the media in the last year are not major factors for energy investors, who see bigger opportunities in exploration and production of oil and gas.
“The UK energy market is a small sum of money relative to the US and the rest of the world. Investors are not investing in utilities, but in service companies and refineries. UK equities amount to 10% or less,” Waghorn commented.
A similar view is expressed by Iain Armstrong, oil and gas analyst at Brewin Dolphin.
“The [UK energy] sector has been out of favour for nearly two years. This has been partly due to worries over oil prices given the surge in shale oil production in the US,” he said.
The Global Picture
On a global level, the energy sector may however offer investors some return on their cash.
Disruptions to supply in regions such as Syria, Sudan, Nigeria, Libya and Kazakhstan have coincided with increases in demand in the US while gasoline demand in the Eurozone has seen modest recovery.
Demand in China has also held up despite the weakness in economic growth with subdued demand for diesel being offset by increased demand for gasoline as a result of the increase in car ownership.
According to Brewin Dolphin, the ‘hot areas’ for investment are North Africa (Cairn Energy), East Africa, particularly Tanzania, Kenya and Mozambique, (BG Group, Tullow, ENI) and Kurdistan (Genel and Gulf Keystone, both not covered yet).
Renewables
A relative newcomer to the established energy sectors are renewables, which saw an exceptionally good year in 2013.
“Renewables was one of the best performing sectors last year, but this is mostly because it had been performing very badly in the four years previously,” Mark Hosken, partner at Holden and Partners, said.
Sentiment picked up and stabilised in 2013, scattering earlier concerns about China undercutting prices of renewables products such as solar panels. The biggest interest in renewables of UK equity investors are infrastructure. Cash flow going forward is looking promising in projects such as wind parks.
"There is no doubt that the global renewables market is growing. The question is will companies make a profit," Hosken said.
To Invest or Not Invest
Faced with the decision whether or not to place any eggs in the energy basket this year, investment professionals should consider global trends and embrace cautious long-term thinking.
“As long as oil prices remain around current levels and the oil majors remain very selective on developments and do not go over-budget, we think that the outlook for the main components of the index (BG, BP and Royal Dutch Shell) will see improvements in their free cash flow,” Armstrong from Brewin Dolphin said.
But bold investors may take advantage of declining prices in the energy world and seize a few deals while the glut is depressing the market value of oil and gas.
According to Waghorn, “Every investor is a contrarian at heart.”
