Broker Check

Energy a Big Drag

In case you didn’t notice, the energy sector took it on the chin with regard to performance in the most recent second quarter. Led by weakness in price from oil and natural gas prices, most energy sectors of the S&P 500, including the more passive energy MLPs, were much weaker than the market in general. Forecasting oil and gas prices is always a difficult task with many volatile twists and turns. Besides the major indicator of economic growth, unrest in the Middle East, major supply disruptions from hurricanes can swing prices dramatically with only minor changes in overall demand. Finally, left to their own methods, the oil and gas industry has the ability to restore stability and profitability by cutting back production and drilling activity

While the sudden drop in oil and gas prices during the last quarter was tough on performance, it should provide some much needed economic growth in the U.S. even as unemployment remains a struggle. Importantly, most of our investments in the Master Limited Partnerships are acting better over the last two weeks that may suggest the sharp drop was an overreaction by investors fearing both the sharp decline of the Euro and a global economic slowdown. My belief is that investors will gradually return to dividend and interest paying energy stocks and bonds in the second half of the year in search of yield and relative safety. Historically, the second half of the year has been kinder to energy group performance due to seasonality and a few natural disruptions (hurricanes).

Looking at the energy service companies is a trickier proposition. First, their profitability depends on a healthy exploration and production environment as well as stability regarding rig count and spending activities from leading oil and gas companies. Last week, Jim Crandell of Dalman Rose, produced his exploration and production spending survey for the second half of 2012. Overall E&P spending will likely increase 11% worldwide, led by international E&P spending forecasting growth of 12% year-over-year in 2012. The difficulty comes into play because if companies are drilling robustly for more oil and natural gas it can have negative short term implications for oil and natural gas prices. Therefore, energy service companies lag the exploration companies in both declining and improving market environments. Similar to insurance companies, a little hurricane and natural disruption activity would not be a bag thing for service companies. I expect these companies to respond better in the fourth quarter of 2012.

Overall, my plan is to focus on the dividend and interest paying companies, top-tier exploration companies, and finally those international service companies taking advantage of growth in emerging markets. As always, there are a number of variables that will play a part in the swings in oil and gas companies. I look forward to the next few months for good investment opportunities.

Have a great week,

Roger N. Steed
July 9, 2012

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