Energy Renaissance: Three Signposts to Watch

by: , Chief Portfolio Strategist, MainStay Investments

Supply concerns took U.S. West Texas Intermediate (WTI) oil prices below $50 a barrel recently, amid nine straight weeks of rising crude stockpiles, before inventories finally declined as reported in the U.S. Energy Information Administration (EIA) March 10 update. Natural gas prices have also slid about 25% of late. We recently checked in with Portfolio Manager, Saket Kumar, of Cushing Asset Management (subadvisor of several MainStay Funds), to deepen our understanding of recent events and how it relates to the investment implications of the U.S. Energy Renaissance underway.

Kumar was quick to point out three signposts to watch for markets to calm down:

Three Signposts to Watch

  1. Inventories need to flatten out and then decline.
  2. OPEC needs to comply with its late November pledge to reduce its oil production.
  3. U.S. rig count growth needs to moderate.

Inventories

The first signpost may now be turning, but according to Kumar, the market’s level of confidence will likely ebb and flow until the draws become more pronounced, leading to bouts of volatility. He and his colleagues believe part of the recent inventory build was seasonal, due to a warm winter, and the picture of inventory draws should become clearer over the next quarter or so.

OPEC

OPEC members have been known to disregard production agreements. That said, in January and February, they’ve stayed the course, thanks to the Saudis shouldering most of the cuts and compensating for members who have not yet made promised output reductions in order to achieve a high collective rate of compliance. In late November, OPEC agreed to lower its combined output by 1.2 million barrels a day. In February, OPEC production was 29.9 million barrels a day versus a target of 29.7 million.

U.S. Rig Counts

Coming off a low base, U.S. oil rig counts are up 57% from a year ago (see chart below). As rig counts move away from last year’s lows and the growth rate moderates, the contours of the supply outlook may become easier to extrapolate.

U.S. Oil Rig Counts Are on the Rise

Source: Thomson Reuters Datastream, as of 3/16/2017. Last data point, 3/14/17.

The Big Picture

The tectonic shift underneath the recent volatility in the energy market is a supply adjustment involving the world’s producers, making room to accommodate the U.S. Energy Renaissance underway. Energy capital investment in the U.S. is on the rise, while like-capital expenditures around the rest of the world are mainly flat to down.

Natural gas prices have also been volatile lately, with prices declining about 25% over two and a half months, according to reporting by The Wall Street Journal. U.S. production is a big factor, with about 8% of output currently exported (60% of this going to Mexico), up from nothing a few years ago. The share of output exported should rise in the future, and the EIA expects the U.S. to be a net exporter of natural gas in 2018 for the first time in 60 years.

It will take time, and there will be moments of supply-demand disequilibrium. However, Kumar and the rest of the investment team prefer working through these types of supply problems, rather than pronounced demand shocks like those of 2015-2016, as China tightened its policy and global industrial production reversed. Demand estimates have been experiencing upward revisions of late.

Five Key Points

Underneath the ups and downs, the U.S. Energy Renaissance is playing out. Kumar and the team highlight the following five key points:

  1. Several beneficiaries of the U.S. Energy Renaissance, including the industrial, manufacturing, and construction sectors, are currently priced at discounted valuations, relative to historical levels.
  2. Industrial production is in an upswing, and infrastructure spending on energy appears to be moving in that direction, too.
  3. Inflation is inching higher. Most of the industries benefiting from the U.S. Energy Renaissance story earn revenue domestically in U.S. dollars, and have historically shown a high correlation to U.S. inflation expectations.
  4. A high share of domestic revenues should likewise reduce the unintended consequences of a strong U.S. currency, should U.S. dollar strength persist.
  5. The prospect of lower corporate taxes ahead should bode relatively well for firms with a high share of domestic revenues.

Conclusion

Energy prices have been volatile of late. Three signposts to watch for calmer markets ahead include inventories, OPEC production, and rig counts. Meanwhile, the U.S. Energy Renaissance is creating long-term opportunities to invest in the crude oil, natural gas, and energy infrastructure value chains.

All investments are subject to market risk, including possible loss of principal.

MLPs and other natural resources sector companies are subject to certain risks, including, but not limited to, fluctuations in the prices of commodities; the highly cyclical nature of the natural resources sector may adversely affect the earnings or operating cash flows of the issuers; and a significant decrease in the production of energy commodities would reduce the revenue, operating income, and operating cash flows of MLPs and other natural resources sector companies and, therefore, their ability to make distributions or pay dividends.

For more information about MainStay Funds®, call 800-MAINSTAY (624-6782) for a prospectus or summary prospectus. Investors are asked to consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus or summary prospectus contains this and other information about the investment company. Please read the prospectus or summary prospectus carefully before investing.

New York Life Investments Management LLC engages the services of federally registered advisors. Cushing® Asset Management, LP is unaffiliated with New York Life Investments.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, New Jersey 07302.

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Charlie Reinhard

Chief Portfolio Strategist, MainStay Investments

As head of portfolio strategy at New York Life’s MainStay Investments, Charlie Reinhard leads investment thought leadership and portfolio construction efforts across MainStay mutual funds and IndexIQ ETFs

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