Future Returns: Investing In the Soaring Energy Sector
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Future Returns: Investing In the Soaring Energy Sector

The sector came roaring back to life late last year on positive vaccine news.

By Karen Hube
Wed, May 19, 2021 10:47amGrey Clock 4 min

Energy has transitioned from the worst- to best-performing sector in a matter of months. How long is it likely to outperform? And which companies are most promising for investors?

Serious difficulties for the energy sector began in April 2020. Demand screeched to a halt under pandemic lockdowns, and the futures prices on the global benchmark West Texas Intermediate (WTI) cratered to negative territory for the first time. The per-barrel price plummeted from US$18 to negative US$37 due to oversupply as Covid-19 crippled industry and mobility around the globe.

But the sector came roaring back to life late last year on positive vaccine news and surged through this year’s first quarter, as successful vaccine rollouts enabled relaxation of Covid-19 restrictions and economic activity rekindled.

In the first quarter, many big oil companies banked a profit for the first time since the pandemic began. Meanwhile, investors have been soundly rewarded. Through last week, the energy sector was up 35% this year compared to 9.5% for the S&P 500.

Bull or Bear?

Sam Halpert, Philadelphia-based chief investment officer at Macquarie Investment Management who oversees the firm’s natural resources equity strategy, views the recent outperformance as a cyclical bull market in the context of a secular bear market for the sector.

“The bull market could last two or three years, but there are still long-term issues around hydrocarbon and the energy transition that will impact the sector,” Halpert says.

The energy sector was under pressure even prior to the pandemic as investors were increasingly hesitant to commit capital as an inevitable transition from fossil fuels to greener choices loomed.

Lack of capital flowing into energy companies focused on shale technology is a hindrance to oil production. “Investors have not been willing to finance shale, there’s been a decrease in investment and production,” Halpert says. “Production was 11 million barrels a day last week, and we peaked at 13.1 million barrels a day in March 2020.”

Pressure on the sector isn’t likely to let up. In fact, the transition from the U.S.’s reliance on fossil fuels to low-carbon energy alternatives has renewed political momentum under President Joseph Biden, who supports policies that elevate greener alternatives and aims for the U.S. to have a 100% clean energy economy and net-zero carbon emissions by 2050.

Investors’ decline in interest in energy has been steady and notable. In 1980, the sector accounted for almost 30% of the index. By 2019 the percentage was 5.3% and this it slipped to 2.33%.

While energy will clearly be impacted over the long term by fundamental changes, “there are a lot of companies that can benefit during the transition and are changing the way they do things,” Halpert says. “They’re becoming more environmentally friendly or changing business slightly to areas that have more growth, and the market is rewarding that.”

Consolidation Boom

Some of the best opportunities are among companies that are not only accommodating environmental factors in the way they do business, but that are sound enough to be gobbling up smaller players in what has been a highly fragmented industry.

The consolidation has been rapid: For example, in late 2019, Parsley Energy of Midland, Texas, acquired Denver-based Jagged Peak. Since then, Parsley was acquired by Pioneer Natural Resources of Irving, Texas, which in May completed the acquisition of Midland, Texas-based DoublePoint Energy.

A central region for the consolidation boom is the Permian Basin, a 75,000-square-mile region from West Texas to Southeastern New Mexico. With rich oil reserves discovered some dozen years ago, it now accounts for more than one-third of oil production in the U.S. Just two years ago the Permian Basin unseated Saudi Arabia’s Ghawar oilfield as the biggest producer in the world.

“There have been too many players, many with marginal acreage or fields they’re developing,” says Geoffrey King, senior vice president and portfolio manager at Macquarie. As investor capital has declined, many of the smaller players have struggled.

King looks for opportunities among companies with sustainable practices that are in position to buy the smaller players. They’re benefiting from strengthened commodity prices and a perked-up demand.

“They have the ability to not only develop and maintain a growth rate comparable to the overall average S&P 500 growth rate, but to deliver excess cash to shareholders,” King says. “The model is being proven out and we’re in inning two or three.”

Veteran Industry Players

Among biggest holdings in Halpert’s and King’s institutional strategy is Plano, Texas-based Denbury (DEN), one of their few small-cap names that focuses on producing carbon negative barrels oil through carbon sequestration, which is the process of capturing and storing carbon dioxide.

“As people talk more about carbon sequestration, this is the game in town,” King says. “A lot of industrial companies don’t want to deal with the complexity of storing carbon. We think this is a very unique small-cap story that’s underappreciated.”

Another is Valero, the San Antonio-based largest independent refiner in the U.S.

“It has best-in-class assets and best-in-class management team,” Halpert says. “They’ve done a really good job returning capital to shareholders over the last several years.”

The company recently entered into an agreement with Darling, which processes waste such as from meat processing plants and the leftover oil from restaurants and food businesses. Valero transforms the waste into the fuel equivalent of ethanol.

“It has the identical chemical properties as ethanol, but ethanol has constraints around usage. It’s tough in the cold weather because it can cause engines to clog,” Halpern says. “Valero’s product is a low carbon fuel and low cost to produce.”

Another noteworthy holding is the big oil service company Schlumberger (SLB), based in Houston but with a global reach. “It’s involved in lithium, carbon sequestration, and a number of technologies that will be important in the energy transition,” Halpert says.

While there are numerous new entrants to the energy transition play, “we prefer to play it with a company with a balance sheet like Schlumberger and the technology of Schlumberger.”

Reprinted by permission of Penta. Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: May 18, 2021



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Europe’s economy has a north-south divide—and now it’s the poorer south that is powering the region’s return to growth.

Southern Europe, which for decades has had lower growth, productivity and wealth than the north, powered an upside-down recovery on the continent at the start of the year. Buoyant tourism revenue around the Mediterranean helped to offset sluggishness in Europe’s manufacturing heartlands.

The south’s transformation from laggard into growth engine reflects both a rapid rebound in visitor numbers from the collapse during the Covid-19 pandemic and a series of blows the continent’s large manufacturing sector has suffered, from surging energy prices to trade conflicts.

Now growth in the south is more than offsetting the north’s manufacturing malaise: As a whole, the eurozone economy grew at an annualised rate of 1.3% in the first quarter, ending nearly 18 months of economic stagnation in a sign that the currency area is recovering from the damage done by Russia’s invasion of Ukraine.

It was the eurozone’s strongest performance since the third quarter of 2022, and approached the U.S. economy’s 1.6% first-quarter growth rate, which was a slowdown from a racy pace of 3.4% at the end of last year.

In the 2010s, Germany helped to drag the continent out of its debt crisis thanks to strong exports of cars and capital goods. Between 2021 and 2023, Italy, Spain, Greece and Portugal contributed between a quarter and half of the European Union’s annual growth, according to a report last year by French credit insurer Coface —a trend now confirmed and amplified in the latest data.

In the first quarter, Spain was the fastest-growing of the big eurozone economies. It and Portugal recorded growth of 0.7% in the three months through the end of March from the previous quarter, while Italy’s economy grew by 0.3%. France and Germany both grew by 0.2%, the latter rebounding from a 0.5% quarter-on-quarter contraction at the end of last year.

This means Germany’s economy has grown by 0.3% in total since the end of 2019, compared with 8.7% for the U.S., 4.6% for Italy and 2.2% for France, according to UniCredit data.

In Spain, strong growth “seems to have been entirely due to strong tourism numbers,” said Jack Allen-Reynolds, an economist with Capital Economics. Tourism accounts for around 10% of the economies of Spain, Italy, Greece and Portugal.

The euro rose by about a quarter-cent against the dollar, to $1.0725, after the latest growth and inflation data were published.

The recovery comes as the European Central Bank signals it is preparing to reduce interest rates in June after a historic run of increases since mid-2022 that took it the key rate to 4%. Inflation in the eurozone remained at 2.4% in April, while underlying inflation cooled slightly, from 2.9% to 2.7%, according to separate data published Tuesday.

“The ECB hawks will point to the strong GDP number as [an] argument that ECB can take its rates lower gradually,” said Kamil Kovar, senior economist at Moody’s Analytics.

The eurozone economy has flatlined since late 2022 as Russia’s attack on its neighbor sent food and energy prices soaring in Europe and sapped business and household confidence. Gross domestic product fell in both the third and fourth quarters of last year, meeting a definition of recession widely used in Europe, but not in the U.S.

Southern Europe is one of only a handful of regions where international tourist arrivals returned to pre pandemic levels last year, according to United Nations data. Tourism revenue across the EU was one-quarter higher in the three months through the end of last June than in the same period in 2019, according to Coface data.

The recovery in international tourism was “notably driven by the arrival of many Americans who…were able to take advantage of favorable exchange rates,” Coface analysts wrote. “On the other hand, the end of the zero-Covid policy in China has initiated a gradual return of Chinese tourists, although remaining below 2019 levels.”

In Portugal, the number of foreign tourists hit a record of more than 18 million last year, up 11% compared with the prepandemic year of 2019, official data showed in January. American tourists in particular have returned to Europe in force.

Tourist numbers in Asia Pacific and the Americas continued to lag 2019 levels by 35% and 10% last year, respectively, the data show.

It is unclear how much further the tourism boom can run, but economists expect the region’s economic recovery to strengthen later this year as cooling inflation boosts household spending power and lower energy costs aid factory output.

Recent surveys point to an improved outlook for growth. Consumer confidence has risen to its highest level in two years, and a leading business-sentiment index has shown steady improvement from the start of 2024.

“We think that the combination of a robust labor market, comparatively strong wage hikes and lower inflation compared with last year will finally lead to a moderate recovery in consumer spending in the next few quarters,” said Andreas Rees , an economist with UniCredit in Frankfurt.

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