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.
- As at 31 July 2017.
To find out more about our high conviction, global contrarian approach to investment go to: www.thescottish.co.uk
About the Author
Alasdair joined the Company in 2003 and became Manager in 2015.
He has 17 years of investment experience. He graduated MA with honours in Economic and Social History from the University of Edinburgh and MSc in Investment Analysis (with distinction) from the University of Stirling. Alasdair is a CFA® charterholder and an Associate of the UK Society of Investment Professionals
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