While for some the fluctuating oil price – with Brent crude averaging $54 a barrel in Q1, $62 in Q2 and $58 so far in Q3 – is serving to shore up reticence over the sector, for others it is a window of opportunity.
Despite oil having dropped to $49 a barrel as at 1pm on 6 August, Ball, portfolio manager with the Templeton Global Equity Group, is happy to play the waiting game
“When you are doing something that no one else is doing, you know you are in the right part of the market,” he said.
“Everyone is saying that the end of oil is upon us, but this crisis is no different than any other. Historically, oil never falls for more than nine months, and typically takes around 22 months to normalise – from the bottom, gains can be up to 150%.”
Throwing pennies in the well
Off the back of strong performance from pharmaceutical and medical science companies, in February Ball reduced his healthcare weighting and increased his energy firm exposure from 6% to 10.8% of the 110-stock Global Equity Group portfolio.
With holdings including BP, Shell, Total and Baker Hughes, Ball believes that despite the current supply/demand imbalance and stockpiles of reserves, investors who buy while the sector is out of favour will see the benefits over the next three to five years.
“As with the banks three years ago, when a sector gets to 0.6x price-to-book you know that it is in value territory,” he expanded. “It is an early-stage sector for us, and is where the double-value potential stands.
“We have a $70 a barrel oil price assumption in the next three years. It is possible that demand could dramatically drop away, but, looking at the supply curve, it looks as though the demand curve will hit that at around $65-70. If we then compound that out using interest rates over the next five years, it reaches $80 a barrel.
He continued: “We want to be in the companies that have the capital to wait for the oil price recovery – we look for strong balance sheets and are happy to wait for the oil price to come back up. The oil companies have promised to cut CAPEX, and that is the sort of environment we want to be buying these stocks in – when bad news is good news.”
“Shell’s acquisition of BG is just crazy, but the cost-cutting that will come through to combined shareholders will more than make up for the planned CAPEX cuts. It will not happen very soon, but we are on a trajectory.”
Potential slick-ups
While from Ball’s standpoint there is historical data that indicates serious upside potential for those who buy in now, he concedes that he is wary of the diverse basket of risks, including the lifting of Iranian trade sanctions, the US shale industry and diminishing emerging market demand.
“The worrying thing is that US shale production does not seem to be tailing off,” he said. “There are lots of risks – political, Saudi Arabia and Iran, etcetera – but, while I do not have a crystal ball, the US threat is easier to track going forward.
“While the oil price fell $15 in a matter of weeks, the supply/demand fundamentals have not changed. When you add up all of the CAPEX cuts that have been announced by the integrators, supply should be coming down dramatically. That said, we are not seeing it yet in the US shale risk.”
