DIY Investor Magazine
| August 2017
10
OIL: THE CONTRARIAN CASE
So far this year, oil has been distinctly out of favour. The
MSCI AW energy sector has fallen some 13% in 2017
(1)
,
and Brent crude has officially entered a bear market
earlier in the year. Although the oil price has risen from
its trough of early 2016, when it fell as low as $28 per
barrel, the revival has petered out. Optimism about
concerted action to reduce the supply glut has also
subsided, as OPEC’s recent cut agreement has failed to
eliminate the surplus. Meanwhile, Libya and Nigeria are
threatening to offset the fall in output elsewhere. And the
future of OPEC’s deal with Russia is already in doubt.
Nor is the outlook for US supply any rosier. The number
of rigs operating in US fields has more than doubled
over the past year. Many shale wells have been taken
offline because of the oil-price slump, but these can be
rapidly brought back online – sometimes in as little as
a week. Thanks to cost restructuring and improvements
in well technology, shale producers can now pump
profitably at $40 rather than at $65, as previously. That
could constrain any potential oil-price upside, because
the shale producers can jump back in as soon it
becomes profitable.
To most investors, all this gloom is a signal to stay away.
The consensus is that the oil price will be low for the
foreseeable future, and so oil companies are unwise
investments.
The aversion also has an ethical dimension, as a focus
on sustainable investment is discouraging investment in
fossil-fuel producers.
AT THE SCOTTISH, WE LOVE CONSENSUS. WE
JUST DON’T LIKE TO BE PART OF IT.
Market consensus provides contrarian opportunities. It
can be uncomfortable to stand apart from the herd, but
it’s where the greatest rewards are to be found.
And we do see opportunities in oil. We believe investors
are overlooking the world’s reliance on fossil fuels. Just
because a commodity is plentiful doesn’t mean that it
isn’t necessary. What matters to the producers is not so
much the oil price, but their ability to stay competitive
– and profitable. The oil-price slump has already
flushed out many weaker operators. So, the surviving
companies have come through some ferocious natural
selection. Operationally, the oil majors are more fit for
purpose than they have been for 20 years.
Patience may be needed while valuations recover.
But investors are paid to wait. The oil sector offers
compelling dividends, with the six largest oil firms all
paying out 4% or more.
We also think that ethical concerns will abate, because
the oil companies are taking their environmental
responsibilities increasingly seriously. Exxon, for
example, has joined a climate-leadership council.
And all of the large oil companies have signalled their
disapproval of Donald Trump’s decision to pull out of the
Paris Agreement.
Ultimately, everything is cyclical – and oil is no
exception. The world’s reliance on fossil fuels will
see the sector through its current tough times. In the
meantime, we are confident that companies that have
weathered the downturn can reap the benefits when the
oil price recovers.
To find out more about our high conviction, global
contrarian approach to investment go to:
(1)
As at 31 July 2017.
Alasdair McKinnon
Manager
