Future Returns: Investing In the Soaring Energy Sector
The sector came roaring back to life late last year on positive vaccine news.
The sector came roaring back to life late last year on positive vaccine news.
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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New research suggests spending 40 percent of household income on loan repayments is the new normal
Requiring more than 30 percent of household income to service a home loan has long been considered the benchmark for ‘housing stress’. Yet research shows it is becoming the new normal. The 2024 ANZ CoreLogic Housing Affordability Report reveals home loans on only 17 percent of homes are ‘serviceable’ if serviceability is limited to 30 percent of the median national household income.
Based on 40 percent of household income, just 37 percent of properties would be serviceable on a mortgage covering 80 percent of the purchase price. ANZ CoreLogic suggest 40 may be the new 30 when it comes to home loan serviceability. “Looking ahead, there is little prospect for the mortgage serviceability indicator to move back into the 30 percent range any time soon,” says the report.
“This is because the cash rate is not expected to be cut until late 2024, and home values have continued to rise, even amid relatively high interest rate settings.” ANZ CoreLogic estimate that home loan rates would have to fall to about 4.7 percent to bring serviceability under 40 percent.
CoreLogic has broken down the actual household income required to service a home loan on a 6.27 percent interest rate for an 80 percent loan based on current median house and unit values in each capital city. As expected, affordability is worst in the most expensive property market, Sydney.
Sydney
Sydney’s median house price is $1,414,229 and the median unit price is $839,344.
Based on 40 percent serviceability, households need a total income of $211,456 to afford a home loan for a house and $125,499 for a unit. The city’s actual median household income is $120,554.
Melbourne
Melbourne’s median house price is $935,049 and the median apartment price is $612,906.
Based on 40 percent serviceability, households need a total income of $139,809 to afford a home loan for a house and $91,642 for a unit. The city’s actual median household income is $110,324.
Brisbane
Brisbane’s median house price is $909,988 and the median unit price is $587,793.
Based on 40 percent serviceability, households need a total income of $136,062 to afford a home loan for a house and $87,887 for a unit. The city’s actual median household income is $107,243.
Adelaide
Adelaide’s median house price is $785,971 and the median apartment price is $504,799.
Based on 40 percent serviceability, households need a total income of $117,519 to afford a home loan for a house and $75,478 for a unit. The city’s actual median household income is $89,806.
Perth
Perth’s median house price is $735,276 and the median unit price is $495,360.
Based on 40 percent serviceability, households need a total income of $109,939 to afford a home loan for a house and $74,066 for a unit. The city’s actual median household income is $108,057.
Hobart
Hobart’s median house price is $692,951 and the median apartment price is $522,258.
Based on 40 percent serviceability, households need a total income of $103,610 to afford a home loan for a house and $78,088 for a unit. The city’s actual median household income is $89,515.
Darwin
Darwin’s median house price is $573,498 and the median unit price is $367,716.
Based on 40 percent serviceability, households need a total income of $85,750 to afford a home loan for a house and $54,981 for a unit. The city’s actual median household income is $126,193.
Canberra
Canberra’s median house price is $964,136 and the median apartment price is $585,057.
Based on 40 percent serviceability, households need a total income of $144,158 to afford a home loan for a house and $87,478 for a unit. The city’s actual median household income is $137,760.
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