67 WALL STREET, New York - November 7, 2012 - The Wall Street Transcript has just published its Investing Strategies Report offering a timely review of the market for serious investors and industry executives. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.
Topics covered: Socially Responsible Investing - Value Investing - Small-Cap Investing - Evidence-Based Investing - Risk Management - Downside Protection
Companies include: China Petroleum & Chemical Cor (SNP), PetroChina Co. Ltd. (PTR), CNOOC Ltd. (CEO), Valero Energy Corp. (VLO), Exxon Mobil Corp. (XOM), Chevron Corp. (CVX), BP plc (BP), Enersis S.A. (ENI), Total SA (TOT), Helix Energy Solutions Group, (HLX), Peabody Energy Corp. (BTU), Cameco Corp. (CCJ)
In the following excerpt from the Investing Strategies Report, an experienced portfolio manager discusses the outlook for the Oil and Gas sector for buy side investors:
TWST: So where is the macro telling you to look right now?
Mr Guinness: I've run this fund for 13 years, and as I look back, I can see definite phases. From 1999 to 2000, the big deal was the oil prices recovering from being oversold. The place to be was the service stocks, which had got completely crushed, and some of the independent oil companies. Not in the super-majors and the big integrated stocks.
And then from 2000 to 2003, the world was much much more difficult. And basically, the name of the game was to spread your investment capital around. The oil price was gyrating, gas prices similarly, markets were falling, tumbling and so on. We sold most of our service stocks and retreated into good value, midcap integrated and exploration and product companies.
And then from 2003 to 2008, powerful trends began to re-establish themselves, most notably a strongly rising oil price, followed later by a rising natural gas price. Quite early on we went into oil sands and emerging market large caps, both of which did well for us. We later switched the fund at one stage quite heavily toward gassy E&Ps, and toward the end of the phase, we had a good exposure to independent refiners exploiting a boom in their margins in 2006 and 2007 - for example, companies like Valero (VLO).
Then in 2008, we saw a classic price spike in the oil price. We worried what would come next. We had done extremely well out of holding stocks that were commodity-price sensitive, and so we decided to try and shift the portfolio into the safer large-cap integrated stocks, and we did that. And we actually broke one of my portfolio construction rules, again. Instead of having each unit at 3.3% for the integrated, we basically ramped up the unit size from 3.3% to 4%. It was a risk-control mechanism.
Then from 2009 to this June, oil prices and gas prices have been quite volatile, and the name of the game has been to make tactical bets, buy stocks that are cheap, sell them when they get expensive. Recently, we have had good exposure to independent U.S. refineries. I think their strong recovery, however, is beginning to slow, and you have to be more careful now. We still have a good weighting to large-cap integrated stocks at the moment.
We also have put about 12.5% of the portfolio back into emerging markets and a similar amount into service stocks that give exposure to recovering Gulf of Mexico activity and the ramp-up in horizontal drilling and hydraulic fracturing.
In summary, about half the portfolio is in relatively stable large-cap stocks, whether integrateds, oil sands or independent refiners - your Exxons (XOM) and Chevrons (CVX), your BPs (BP) and Shells (RDS-A). We've had probably too much in the European stocks, like ENI (ENI) and Total (TOT), but they are very, very cheap now. We were very pleased that one of our oil sands stocks got taken over the other day. Nexen (NXY) was taken over by a Chinese company, giving it a 60% uplift. And we have three independent refiners who have motored.
Rather surprisingly to us, the U.S. refining industry has really turned itself around. It was beaten down by the recession, but now exports to Latin America have been surging. Also, the refiners have had a windfall because of the divergence that has emerged between WTI and Brent due to the interesting success in development of shale oil in the Eagle Ford and the Bakken basins and now the Permian basin. The Permian and the Bakken are basically feeding oil into Cushing, which is where the WTI benchmark is set. There are not enough pipelines to get these increases in supply down to the coast so WTI is depressed relative to the oil price at the coast, which tends to track Brent. Refineries that are able to access WTI are enjoying a good, albeit temporary, boost to their margins.
We are also interested in the growth in gas demand in China, which is going to be very strong over the next eight years. We believe that Chinese consumption of natural gas is going to go from 10 Bcf today to 40 Bcf a day by 2022. To put that into context, the U.S. today consumes 70 Bcf per day, so China only consumes one-seventh of what the U.S. does. Now in terms of oil, China consumes about 10 million barrels a day, which is about half the U.S. As far as coal goes, China consumes two and a half times as much coal as the U.S does.
These different proportions in China's consumption of gas, oil and coal relative to the U.S. highlight imbalances that are going to unwind. And as this happens, the amount of gas they consume will rise exponentially. It has been rising from a very low base for the last 12 years, at about 17% per annum, and that is going to continue. One of the stocks involved with this that we like is PetroChina, and we are now looking quite hard to see if there are other stocks we can invest in to benefit from this development.
Back in the U.S., we are increasing our weighting to gassy exploration and production stocks. We believe we are moving into a period where we are able to see much more clearly what is going to happen. We believe the oil price will be stable, while the gas price is going to recover over multiple years. This is going to cause a great boom for U.S. natural gas companies. They are oversold at the moment and they are going to recover very nicely over time.
There are many people who say U.S. gas is going to remain very cheap for a very long time, and they are wrong. I agree the natural gas price won't get very expensive, but it will move from being ridiculously cheap to a long run price per mcf, of, say, $6 maybe next year but more likely in 2014 or 2015. The current spot price is $3. It went as low as $2. For much of the last decade, it was trading at $8, and it went up to $12 to $14. And today, it trades in Europe at about $9; and in Asia, it's about $15. And natural gas at $6 will still be very cheap compared to oil - 40% of oil's value per BTU - energy content - if oil is $90 per barrel.
And these gassy E&P companies will grow these gas shales that they have now developed in a much more measured way than over the last five years. And as they grow steadily, demand from the electricity utility sector will grow commensurately, and likewise, gas will go on replacing oil for heating.
We're also going to see industrial demand pick up quite usefully, and I think we will see some traction from increased use for transportation, and lastly, maybe exports will begin to happen. Export of gas via LNG is a bit of a political issue, and there is a question of whether the U.S. government will allow the export of gas. We expect so, but only in moderation. But whatever the U.S. does, Canada will start exporting.
So the fund is now usefully, albeit not excessively, exposed to the recovery in U.S. gas prices, and we are also looking for ways to get more exposure to rising gas demand in China. At the same time, we are expecting to see the fund enjoy a very large recovery in the value of our oilier companies. So while there are quite a few other themes in the portfolio, that's the big picture.
TWST: Please tell us about the service stocks. What are your views on those?
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