Crude Oil: Current Price Action Creates Opportunities
After a remarkable recovery in 2016, crude oil is back in bear-market territory, as West Texas Intermediate crude prices fell more than 20% from the start of the year.
Beginning in 2014, an unfavorable supply-demand balance triggered a collapse in oil prices. In the years following, we saw the number of active oil rigs in the U.S. plummet, and a critical set of oil-producing nations came together to curb production. This helped fuel a strong rally in crude prices through 2016.
U.S. Active Rig Count
Source: Thomson Reuters Datastream, as of 6/29/17.
A revival in U.S. crude production has again raised concerns. A persistent inventory glut, along with an increase in output by countries like Libya and Nigeria, has only added to oversupply woes. As expected, investors are worried. Year-to-date through mid-June, the S&P 500 Energy sector is down 14%, and the Alerian MLP Index is down close to 10%.
Energy Underperforms the S&P 500 Index This Year
Source: Bloomberg, as of 6/29/17. Past performance is no guarantee of future results, which will vary. An investment cannot be made directly into an index.
However, we believe that current price action has created attractive opportunities. The current state of upstream and midstream firms in the U.S. is much improved from a few years ago. Their balance sheets are healthier, distributions have already been curtailed, and capital has already been raised for the current set of projects.
In addition, with technological advances, U.S. shale producers continue to drive their breakeven costs lower. As a result, they can continue to operate profitably at lower oil prices. Despite weakness in crude prices during the first quarter of 2017, energy companies posted impressive earnings growth. The trend is expected to continue during the second quarter, with year-over-year earnings for the sector expected to grow by a multiple of three to four times!
Earnings for the S&P 500 more broadly are also healthy, with earnings and revenues continuing to pick up. In our opinion, strong labor markets, solid order flows, and high consumer confidence point to favorable economic conditions, which are supportive of continued growth.
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The Alerian MLP Index is a float-adjusted, capitalization-weighted index, whose constituents represent approximately 85% of total float-adjusted market capitalization. It is disseminated real-time on a price-return basis (AMZ) and on a total-return basis (AMZX).
The Standard & Poor’s 500 Index (S&P 500) is an index of 500 stocks seen as a leading indicator of U.S. equities and a reflection of the performance of the large cap universe.
The S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the GICS energy sector.
Midstream firms includes the processing, storing, transporting and marketing of oil, natural gas and natural gas liquids.
Upstream firms deal primarily with the exploration and initial production stages of the oil and gas industry.
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