Prospecting for Opportunities in Energy Markets

Prospecting for Opportunities in Energy Markets

Oil prices fell dramatically in 2014, but the market has been slowly climbing back since the beginning of last year. Our U.S. Value Equity Team is using this opportunity to identify high-quality, energy-related companies that may be temporarily selling at a discount.

Supply and Demand Begins to Rebalance

Energy stocks bounced back in 2016 as supply and demand in the crude oil market began moving back into balance. The price of Brent crude oil recovered from early 2016 lows driven primarily by two factors: production declines from the swing source of production (U.S. shale) and healthy demand growth.

The most recent increase in crude oil prices has been driven by the late-November agreement among OPEC and non-OPEC suppliers to cut production by approximately -1%, thereby moving the market into a supply deficit and driving down the level of global inventories.

OPEC vs. Non-OPEC Suppliers
OPEC (Organization of Petroleum Exporting Countries): An intergovernmental organization that includes the governments of Iran, Iraq, Kuwait, Saudi Arabia, Venezuela and other member countries.

Non-OPEC: Oil-producing countries outside of OPEC, such as the U.S., Russia, North Sea operators (U.K. and Norway) and Brazil. Smaller countries in Latin America, Africa and Asia are also non-OPEC producers.

What Caused the Drastic Decline in Oil Prices in 2014?

New technology like fracking enabled non-OPEC supply to grow faster in 2014 than at any time in the last 30 years, tipping crude oil markets into a surplus state. Typically, OPEC producers rebalance the market by cutting supply levels. But having lost market share to non-OPEC producers, the organization refused to cut production. Indeed, OPEC producers aggressively increased production and flooded the market in an attempt to take back market share. Eventually, production economics forced non-OPEC production to decline enough to balance crude oil markets, and OPEC more recently returned to its historical role as price setter.

Brent Crude Oil Price Recovering from 2016 Lows

Brent Crude Oil Price Recovering from 2016 Lows
Data from 6/30/2014 to 12/31/2016. Source: Morningstar. Brent crude is a classification of sweet light crude oil that is used as a major pricing benchmark for global oil purchases.

Our 2017 Energy Outlook

Since the dramatic fall in oil prices in late 2014, the U.S. Value Equity Team has believed that these low levels were unsustainable and that the commodity would recover as supply-demand forces balanced out.

We’ve also continued to believe that well-managed energy companies were good investment opportunities. Companies carrying too much leverage were unattractive, in our view, as bankruptcy risk was prevalent in the market. Instead, we looked to higher-quality names with strong balance sheets, This past year’s recovery in oil prices has caused many high-quality companies to appreciate, and we’ve begun to trim our energy holdings to lock in gains in our portfolios.

OPEC’s supply cut could materially drive down global inventories in 2017, thereby solidifying the path to normalization of oil prices. In turn, higher oil prices could drive the continued recovery in the stock prices of well-managed energy companies. Accordingly, we maintain overweight positions to the energy sector in our portfolios as we believe many of our holdings have more potential upside. As our energy stocks continue to rise, we will trim our holdings as necessary to take profits. We are also poised to take advantage of any dislocations in the market and add more to our holdings if prices become more attractive.

The opinions expressed are those of Matt Oldroyd, CFA, CAIA, and are no guarantee of the future performance of any American Century Investments portfolio. For educational use only. This information is not intended to serve as investment advice.