Streaming the U.S. Energy Renaissance

by:
Portfolio Manager, Cushing Asset Management

Volatility in the energy sector is certainly not a new phenomenon. And, this is likely to persist, given the U.S. Energy Renaissance, supply and demand trends, geopolitical issues, and shifting investor sentiment. At the same time, investing in U.S. equities benefiting from the North American shale revolution has the potential to result in attractive, long-term total returns. So, how should an investor play the energy sector? In a word: diversify.

We believe a U.S. energy allocation shouldn’t be just pure upstream (production), midstream (transportation, storage), or downstream (refining, marketing). Rather, a diversified strategy, which can move across the value chain based on the most compelling opportunities, is a more prudent strategy. And through active management, an energy portfolio can be adjusted to seek to capitalize on changing commodity prices, fundamentals, and other factors.

U.S. Energy Renaissance: Producers, Movers, and Users

Natural Gas, Crude Oil, and Energy Value Chain

Estimated investable universe: 642 companies with approximately $5.3T market capitalization, as of 6/30/17. Number of companies and combined market cap of relevant Russell 3000 Index industry groups.

The following is a summary of the various components of the U.S. energy market and our outlook for the sector as a whole.

Three Streams of Opportunity

  • Upstream: Producers of Oil and Natural Gas — These companies have been a key driver of the North American Energy Renaissance. By developing innovative technologies to extract oil and natural gas from shale deposits, U.S. upstream companies have become among the cheapest producers in the world, especially for natural gas.
  • Midstream: Energy Infrastructure — Companies that provide the backbone of the U.S. energy market. They include transportation, storage, pipeline, treatment, and processing companies. These companies are less impacted by the underlying commodity prices versus their upstream counterparts. We believe midstream fundamentals are solid, and they continue to offer attractive yields.
  • Downstream: Product Users — Companies that are typically product users in the commercial, industrial, and residential spaces. They can also include trucking companies and railroads that transport oil or frac sand used in the production of oil. There are two components of downstream: companies that benefit from increased volume and capital expenditures and those companies that benefit from lower costs.

Not only can an energy portfolio be diversified among the three “streams,” it can also be levered to the type of commodity, whether it’s oil, natural gas, or natural gas liquids (NGL).

Pulling the Streams Together

In terms of our outlook for the U.S. energy market, we see valuation opportunities on the margin. Looking ahead to next year, we are constructive on the U.S. energy industry in general, and have balanced allocations among the three streams. In our view, inflation will pick up, which should be beneficial for industrials, materials, and energy — all of which have a fairly high correlation. In terms of industrial users, they expect to recoup increased commodity prices through improved pricing power. Even when interest rates go up, these companies tend to do well. We also have a very good activity-level story, coupled with increased oil prices, which could benefit both upstream and midstream companies. Finally, if we get any kind of infrastructure bill and/or tax reform, this would be a net positive for the U.S. energy space, as these are mostly U.S. companies.

Six Reasons to Invest in the U.S. Energy Renaissance Strategy Now

  1. Seeks to benefit from inflection in energy prices
  2. Seeks to benefit from resurgence of U.S. industrial economy
  3. Seeks to benefits from inflation through exposure to energy, industrials, and materials
  4. Seeks to benefit from U.S.-focused infrastructure spending
  5. Seeks to benefit from cheap valuations relative to the market
  6. Seeks to lower volatility, relative to traditional energy investment approach

Conclusion

We continue to see numerous long-term investment prospects tied to the U.S. Energy Renaissance. In our view, a diversified allocation across the three “streams,” as well as types of energy, can help manage volatility and expand one’s investment opportunities.

Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.

About Risk

All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.

This material is provided for educational purposes only and should not be construed as investment advice or an offer to sell or the solicitation of offers to buy any security. Opinions expressed herein are current opinions as of the date appearing in this material only.

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.

Commodities are investments in instruments and companies that are susceptible to fluctuations in certain commodity markets. Any negative changes in commodity markets (that may be due to changes in supply and demand for commodities, market S‐4 events, regulatory developments or other factors) could have an adverse impact on those companies.

“Frac sand” is a high-purity quartz sand with very durable and very round grains. It is used in the hydraulic fracturing process (known as “fracking”) to produce petroleum fluids, such as oil, natural gas and natural gas liquids from rock units that lack adequate pore space for these fluids to flow to a well.

The “Shale Revolution” refers to the combination of hydraulic fracturing and horizontal drilling that enabled the United States to significantly increase its production of oil and natural gas, particularly from tight oil formations, which now account for 36% of total U.S. crude oil production.

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 Investment 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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Saket Kumar

Portfolio Manager, Cushing Asset Management

Saket Kumar has worked in investment management and investment banking focused on the energy and industrials sector since 2007. Before joining the firm in his current role, he was an analyst at Citadel Investment Group in their long short market neutral hedge fund strategy

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