Over the past decade, the United States has gone through an energy renaissance. Crude oil production has increased by over 120% and the country has gone from one of the most energy dependent to energy dominant. The power of OPEC has been decimated as the U.S. is now the world's largest energy producer.
Despite these vast gains, investors who have helped make this happen have not been rewarded. In fact, almost all energy investments are far below their 2010 price. Just look at the Energy Sector ETF (XLE) vs. the S&P 500:
After years of negative returns, many investors have given up on the energy sector exactly when it may offer the best returns. Energy production growth is likely to slow dramatically over coming years which will likely bring oil prices well over cost of production levels.
Valuations for energy producers are extremely low by historical standards and MLP's as well as corporate energy bonds pay extremely high dividends. I'd personally bet that energy will be one of the best performing sectors over coming years.
As I'll explain, The Cushing Renaissance Fund (SZC) appears to be one of the easiest ways investors can capitalize on this shift.
Before we dig into the fund, we must consider energy commodity prices as that is the primary determinant of any energy investment's performance.
As you can see below, the falling U.S. rig count may be beginning to slow production growth and boost prices:
I realize there is a lot going on in this chart, so let's break it down. First, we can see that the U.S. rig count generally tracks the price of oil. Also, when the rig count falls, production growth typically follows. This has not been true in 2019 since producers have been maximizing per-rig production, but it is clear they will not be able to push that figure much higher (most rigs are currently producing 2-5X normal levels).
Going into 2020, I expect production to stagnate as per-rig production plateaus. Shown in the chart, crude stocks are already at long-term lows so shortages are likely to have a significant impact on oil prices. Thus, it is very likely that crude will pass above $60/barrel and march higher in 2020.
As crude oil rises, it is likely that more rigs will come back online and increase supply but, unlike in the past, producers will not be able to increase per-rig production. This means that supply is likely to consistently run slightly below demand and crude prices will likely return to a long-term bull market.
If a recession occurs (which I eventually expect), demand will likely fall but it will be far different than normal recessions. In 2008 most investors were firm believers in "peak oil" and crude was in a speculative bubble before the crisis. If anything the opposite is true today. U.S. production was also projected to increase in 2008-2010 while it is more likely to flatten from here.
Put simply, this means it is likely great time to invest in energy.
Given there are still many "landmines" among energy companies (those buried too deep in debt for equity survival), active management is likely a better strategy than passive and is likely to be worth a slightly higher expense ratio.
Looking at the data, the Cushing Renaissance Fund may be one of the best ways for passive investors to gain exposure. The fund pays a high yield, has generally outperformed its passive peers, and is currently trading at a nice discount to NAV.
The fund seeks to maximize total returns and income among domestic energy-related investments. This includes explorers and producers, refiners, transportation, and bonds.
Here is the fund's most recent sub-sector allocation:
Personally, I believe the best immediate opportunities are actually in energy bonds since they will likely see credit upgrades soon due to the ongoing rally in crude oil. Energy companies have had the most difficult time getting debt financing lately and some have extremely low CCC and below ratings. As WTI crosses above $60, many distressed firms will become profitable and will likely see rapid bond rallies.
The same can generally be said for Midstream MLP's in the sector as described in my recent article "AMLP: Investor Capitulation Signals A Potential Bottom For MLPs".
Because many of the traditional equities in the energy sector are struggling with interest payments, I'm not as immediately bullish on them, E&P's in particular. That said, as credit ratings improve and the smoke clears, they will likely see tremendous earnings growth and potentially return to 2014 price levels.
As you can see, SZC has managed to outperform both ETF's. The fund also has a high correlation to both as it holds many MLP's and E&P firms as well as the same economic exposure. Interestingly, we can see that all three funds are generally right around their 2016 bottom.
This outperformance is even better when you account for the fact SZC is currently trading around 12-13% below its Net-Asset-Value:
If the fund was trading closer to its NAV it would have even higher total returns since 2014. This demonstrates that SZC has been delivering positive alpha to investors despite having a slightly higher management fee than the passive ETF's.
Overall, it seems clear that the supply-demand economics surrounding energy producers is finally turning favorable. Global crude oil demand is expected to steadily rise over the next few years and there are considerable reasons to believe that supply will not keep up.
Energy companies have been unable to get the financing needed to keep their lower-margin rigs online or explore new potential production sites. Crude demand is already slightly higher than supply and total stocks are around a five-year low. If crude continues to rise, it will take quite a bit of time for producers to turn rigs back online and it is conceivable that crude will rise back over $100/barrel in the 2020s. This will give energy producers and those economically tied to them a much needed windfall profit.
If you want exposure and do not want to do the difficult task of finding the best investments, SZC is a much better option than passive ETF's. I generally prefer ETF's to CEF's since management fees are usually lower, but SZC has a low fee of 1.25% and is trading at a considerable discount to NAV. Even more, SZC's fund managers appear to have outperformed passive benchmarks.
The fact that SZC has bond exposure is an added benefit since I expect energy corporate bonds to deliver the best risk-adjusted returns over the coming months as credit risk subsides due to the recent rise in crude oil.
Overall, SZC is a clear "buy" and I expect the fund to deliver strong returns in both the near term and perhaps consistently over the next 5+ years as the energy market returns to stability.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.