5 Reasons to Still Love the Energy Sector

Aaron Hodson Nov 11, 2014

To view the original story in the Financial Post, please click here.

Having fun in the energy sector yet? The price of oil has recently been decimated because of moves by Saudi Arabia and buoyant U.S. oil production, which is at a 30-year high.

Energy stocks on the TSX have been crushed, with companies such as Crescent Point Energy Corp. down 25% and others down even more in less than three months.

Many energy investors are in full-blown panic mode, forecasting a continuation of deep declines. But we are here to tell you not to panic. Here are five reasons to still love the energy sector.

It’s not the first time an OPEC nation has wreaked pricing havoc

Cartels are supposed to be stable, but they are inherently unstable organizations, as members tend to cheat and do what’s best for themselves

Saudi Arabia recently lowered the premium on its oil in order to fight rising production from the U.S. Long-term investors will recognize, though, that OPEC moves are nothing new.

The cartel has continually caused havoc with oil prices for more than four decades. It can influence prices, but so can other things, such as global growth and political problems in the Gulf.

Low prices are the best cure for low prices

In Business 101 classes, students are taught about price adjustments causing supply adjustments. It is good to remember this now.

Low oil prices will result in less capital spending, which may limit future supply growth. This should temper price declines down the road.

Such a process doesn’t happen overnight, of course. But investors should take the long-term view. Low prices are a great cure for low prices.

Energy has always been a cyclical industry

Oil prices are the lowest they have been in three years. That’s not great for producers, but keep in mind that prices were even lower before.

Most producers have done just fine managing the highly cyclical nature of the industry. Those with debt always get into trouble in the downturns, but a well-financed, quality company simply adapts, tries to lower costs and deals with the situation.

Many companies are still growing very nicely

This is one point investors seem to forget in the downturns. Companies such as Raging River Exploration Inc., RMP Energy Inc. and others continue to increase their productive capacity.

Raging River, for example, increased its production by 116% in the last quarter. A 20% decline in oil prices is barely noticeable when a company is growing at such as fast rate. Per share cash flow still has the ability to grow nicely.

Most oil companies have price hedges in place

Many companies in the sector routinely put oil hedges in place to protect their cash flow and dividends. Baytex Energy Corp. and Surge Energy Inc., for example, have significant price hedges in place. Thus, a decline in prices does not impact all of their production.

Investors, however, tend to treat all barrels the same, whether hedged or not. For a company with significant hedges, this can result in a big mismatch between investor expectations and company reality.

We have talked to a lot of investors anxious about the sector. We think that is largely because the TSX has such a big energy sector weighting, and investors following the TSX sector allocation likely own too much of it.

If you happened to own a 25% sector position (not out of line) in June, then your entire investment portfolio might have been impacted by as much as 8% in the sector’s decline.

The best strategy: Keep a sector weighting you are comfortable with — 10% to 15% is plenty. Buy good, growing companies with solid balance sheets. Then, simply ignore all of the commodity fluctuations. Good companies — if they are truly good — can survive almost anything.



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Nov 16, 2014
Sorry Peter

I posted this comment under the wrong blog. Should go under:

Industry Performance and Tax-Loss Selling

By Ryan
Nov 16, 2014
Hi Rian,

Just found this interesting article. I was just on the phone with my brother who is also a 5i member. We went over some of each other holdings trying to find the best tax loss candidate we have. He said he has some yamana gold and avigilon. I told him I would be nervous risking avo . But yamana...

Here is a question about yamana and gold in general. What do you think of the gold sector as a tax loss this time?