Our strategy has been underweight in the energy sector, but we're exploring for opportunity
By Richard Nield, Senior Portfolio Manager Posted on Expert Investment Views: Invesco US Blog.
Historically, the Invesco International and Global Growth team has taken an underweight position in the energy sector because we believe that over the course of an economic cycle, few oil and gas producers can consistently earn above their cost of capital. Additionally, we see many management teams prioritize volume growth over returns - a strategy that eventually pushes prices down to or below the median break-even cost curve. But after the recent carnage in the oil markets, we are beginning to dust off some of our energy company files in search of opportunities.
A focus on quality will be critical to finding companies that can survive - and thrive - in this space. The majority of energy companies are not able to tap the markets for new debt, and that means more dividend cuts, high-cost equity dilution or high-quality asset disposals are their only options. We expect to see several bankruptcies in 2016
Our view of oil
We think that oil prices of $31 a barrel are not economically feasible for the industry, and at least 1.5 million barrels a day of supply will need to come out of the market to help bring supply and demand back into balance. Indeed, we are likely to see accelerated volume destruction in the second half of 2016 as companies have been cutting their capital expenditures down to maintenance levels: The North American rig count is down 57% year over year, and more than 63% from the 2014 peak.1 In the meantime, however, the Saudis seem prepared to suffer big deficits in order to drive competition out of the market.
While lower quality companies tend to outperform during short-term commodity price rebounds, we believe the higher-quality large caps remain the better long-term plays as we are unlikely to see $80 oil anytime soon. In addition to much faster global growth, a period of US dollar weakness would be necessary for commodity prices to show any positive long-term trends. With US government bond yields paying more than other developed markets, we would need to see that gap begin to close for the US dollar to depreciate.
Our energy holdings
Our largest oil holding is Suncor (NYSE:SU) (1.53% of Invesco International Growth Fund as of Dec. 31, 2015), a Canadian oil sands integrated company that has one of the strongest balance sheets in the sector, as well some of the lowest-cost oil sand assets with a long-life production profile. Suncor is taking advantage of the downturn by agreeing to acquire Canadian Oil Sands (OTCQX:COSWF) for shares (not a holding of Invesco International Growth Fund as of Dec. 31, 2015). This deal would raise Suncor's stake in the Syncrude oil sands project, which is the largest oil sands project in the world and has 40 years of proved and probable reserves.
Another of our energy holdings, Royal Dutch Shell (NYSE:RDS.A), is buying BG Group at a time when few companies have the balance sheets to even contemplate such a deal. (Royal Dutch Shell is 1.26% of Invesco International Growth Fund as of Dec. 31, 2015. BG Group is not a fund holding.)
We believe companies like Suncor and Shell typically come out of these downdrafts much stronger, and should be able to drive higher future returns at a lower oil price.
Learn more about Invesco International Growth Fund (MUTF:AIIEX).
- Baker Hughes, Invesco, Jan. 29, 2016
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Businesses in the energy sector may be adversely affected by foreign, federal or state regulations governing energy production, distribution and sale as well as supply-and-demand for energy resources. Short-term volatility in energy prices may cause share price fluctuations.
Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.
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Looking for companies that can survive - and thrive - with low oil prices by Invesco US Blog