Given that collapse in energy prices, you might think that this isn’t a particularly good time to be investing in energy companies.
Think again.
Oil & energy indices performance
Source: Financial Express Analytics
Not all energy producers are created equal. For those whose production costs are relatively high, and for those servicing debts taken on in happier days, times are undeniably hard. Others, however, are still turning a handsome profit.
Take, for example, Ultra Petroleum, a US natural gas producer whose management I met in Houston last week. Its production costs are the lowest in its industry, allowing it to turn a profit even at current depressed gas prices. That means that even as low gas prices call the continued existence of rivals with higher production costs into question, Ultra is enjoying handsome margins.
That’s all very well, but where will energy prices – and, more importantly, the share prices of energy companies – go next? We’re not in the business of forecasting commodity prices one month, six months or even a year from now. Making these predictions is a mug’s game: many try, most fail. What we can say is that, with oil and gas prices so low, many projects to expand energy production don’t make economic sense. As a result, many energy producers are cutting spending. This will inevitably lead to lower production capacity as declines from existing fields are not offset by new capacity.
The response from producers in the US, UK and Russia is likely to be rapid: it could, potentially lead to the global output of oil falling by one million barrels per day this year from these three countries alone. OPEC has already cut its production by around 4 million barrels since November.
That amounts to a significant reduction in supply. The laws of supply and demand, meanwhile, are inescapable. When demand for energy eventually recovers – which it will – the reduction in supply since late last year will have a dramatic impact on energy prices.
The share prices of some oil and gas producers appear to be discounting oil prices of US$30-40 per barrel into perpetuity. The oil futures market, however, is currently pricing in oil costs of $57 for this year, $65 for next year and of more than $70 per barrel in 2011. That disparity – between commodity markets and equity values – is significant. And it’s a disparity from which investors currently have an excellent opportunity to profit. But hurry – nothing lasts for ever….
Ruairidh Stewart, is co-manager of the Martin Currie Global Energy Fund. The comments here are personal. No recommendation is implied.