Guinness Atkinson Energy Brief

Transcription

1 Guinness Atkinson Energy Brief Number 17 December 2005 By Tim Guinness, Lead Manager of the Global Energy Fund Market Background in November 2005 The oil price (WTI (West Texas Intermediate crude)) opened at $59.76 on November 1 st and closed at $57.32 on November 30 th. At the end of trading on November 18 th it was at $56.14, its lowest level since July 25 th, before increasing 2% by the end of the month. It has since risen a further 4.5%, closing on December 5 th at $ Oil price (WTI) 18 months from 1 st April 2004 to 30 th November 2005 Source: Bloomberg There were both supply and demand factors which brought about the decline in the WTI price over the course of the month. The first was the mild weather in the US Northeast which decreased demand: Heating oil demand was down 30% in the first week of the month and 42% in the second The second factor was the quicker than expected recovery of both refining capacity and oil & gas production in the Gulf of Mexico post-hurricanes Katrina and Rita, which increased supply: On November 2 nd, Exxon s 190 mbd (thousand barrels per day) Chalmette, Louisiana refinery came back on line, meaning that 17 of the 20 US refineries in the Gulf Coast had resumed operations after shutting in August and September page 1

2 At the start of the November, 67.7% of crude and 54.3% of gas production in the Gulf of Mexico were still shut-in. By the end of the month, only 37.6% of crude production and 29.9% of gas production remained shut-in There were also supply and demand factors which bolstered the WTI price over the month On the demand side, the IEA (International Energy Agency) reported that Chinese apparent demand rose by an estimated 8.6% in September On the supply side, there was a week long strike at the RDS Pernis plant, Europe s biggest oil refinery (capacity 418 kbd (thousand barrels per day)) According to Reuters, Iraqi exports reached a 2 year low in October of 1.24 MMBD (million barrels per day). This is the lowest level since November 2003, with bad weather and sabotage cited as the principal causes The weather did not stay mild for the whole month: forecaster Meteorlogix predicted on November 23 rd that temperatures in the US Northeast (which consumes 82% of US heating oil) would stay well below normal levels over the following five days. The price of WTI rose 2% that day OECD (Organization for Economic Cooperation and Development) Total Product and Crude Inventories Monthly 1998 to Sept mill. barrels Jan feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec LOW HIGH Source: IEA Oil market report Any growth in total OECD crude and product inventories that might have been expected from OPEC s (Organization of Petroleum Exporting Countries) high level of production has been greatly reduced by the Gulf of Mexico shut-ins post hurricanes Katrina and Rita. page 2

3 Gas Price The US gas price was extremely volatile over the month, falling 20% in the first week from $10.87 to $8.71, before rising 37% in 8 trading days to $11.95 on the 17 th. The price has recently spiked even higher, closing on December 5 th at $ Henry Hub Gas price 1 st April th November 2005 Source: Bloomberg The post month end move has taken the gas price back well outside the historic 6:1-9:1 gas:oil ratio range. Now at $13.44 vs. oil at $59.91 the ratio is 4.5X. Last month I said, $14.5 (per mcf (thousand cubic feet)) has the unmistakeable smack to me of a spike that is unlikely to last more than two/three months. This recent second spike is testing this view. It will be interesting to see what happens this month and next. Some commentators are looking for big gas draws but I think they are underestimating gas demand destruction. I equally note that the level of gas storage inventories is 6.9% above 5-year average levels. Speculative positions There is not at present a big speculative overhang risk. Net non-commercial Nymex oil futures continued short in November and were some 44,000 contracts short at 30th November. As I said last month, this means that when bearish sentiment gets exhausted we could see quite a measure of price support and a price bounce when this unwinds. page 3

4 Non Commercial net futures Nymex crude oil contracts 4th Nov th Nov 2005 Nymex non commercial open interest contracts /11/ /12/ /01/ /02/ /03/ /04/ /05/ /06/ /07/ /08/ /09/ /10/ /11/ /12/ /01/ /02/ /03/ /04/ /05/ /06/ /07/ /08/ /09/ /10/ /11/ Source: Bloomberg/Nymex Nov Nov Oil & gas equities Turning to oil and gas equities, November saw a small rise in stock prices across the board. The main index of oil stocks, the MSCI World Energy index, was up 1.2% during the month. This takes its performance year to date to 27.4% Fund Performance Review Over November the Fund rose 1.48% and thus matched the MSCI World Energy Index. Over the year to date the fund is up 60.95% whilst as already mentioned the MSCI World Energy Index is up 27.4%. Within the Fund November s stronger performers were Canadian Oil Sands Trust, Petro-Canada, Plains Exploration, Shell Canada and Nexen. Poorer performers were Tesoro, Encana, Opti Canada, Amerada Hess and Repsol. Performance data quoted represent past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be lower or higher than the performance quoted. For most current month-end and quarter-end performance, visit or call (800) The Fund imposes a 1% redemption fee on shares held for less than 30 days. For each Fund the total returns reflect a fee waiver in effect and in the absence of this waiver, the total returns would be lower. page 4

5 Energy Fund vs. S&P500 and MSCI Energy Index 17 months since launch 30 June 2004 to 30 th November 2005 Source: Bloomberg Buys/Sells The remainder of the Venture Production holding was sold. We also bought a small holding in a Canadian company called Synenco, which increases our exposure to Oil Sands. The following table shows the asset allocation at various recent dates since end December %s 31Dec June Sept Oct Nov 2005 Change in period Integrated E&P Refining Sub total integrated Emerging Mkts Emerging Markets E&P Oil Sands E&P Sub total E&P Oil Services & Eqt Refining Other Total page 5

6 Market Outlook Much of what I say is a repeat of last month. The future price of equities involved in the energy business will continue for a period to be determined by evolving perceptions of the likely medium term level of the oil and gas price. The immediate future path that the oil price will take is harder than usual to predict. Important imponderables are what will be the demand and supply responses to the late summer s Katrina/Rita inspired $60+ oil price. The driver of higher oil prices in the last 18 months has been the sharp rise in the call on OPEC caused by buoyant Asian (esp. China) and US demand, combined with weakening supply growth from Russia and falling production from the more mature producing areas such as the US and North sea. The following table compiled from data in the latest IEA monthly oil report shows how the call on OPEC has jumped by 2.4m b/d (million barrels per day) (highlighted in blue) in the period. Estimated Annual World Oil Demand Growth Million Barrels per Day World demand Non OPEC supply plus OPEC NGLs (Natural Gas Liquids) Call on OPEC World demand growth Non OPEC supply growth Call on OPEC change Source: IEA Oil Market Report The call on OPEC has taken OPEC production to within 1 or 2 million barrels of believed OPEC capacity. (31.8m b/d per IEA Nov 2005) This strengthens significantly OPEC s ability to secure a higher price for its oil. Will this growth now be blunted by $50+ oil? My best guess is yes it will but probably by rather less than many commentators expect because although the price is now on an inflation adjusted basis back to the level we use 33% less of it per $ of constant dollar GDP so the amount we spend on it is, relative to our current income, still well below the amount we spent in that period. As regards supply again I expect a response principally from independent oil & gas companies but I doubt this will be enough to make a big difference. The important controllers of supply are the National Oil Companies and the Oil majors and here I expect their strategy to continue to be one of growing supply to meet demand growth but NOT to create oversupply. The graph below compares purported OPEC production with the call on OPEC per the earlier table. page 6

7 Source: Bloomberg/IEA Oil Market Report I have been cautioning in previous months that if this continues a period of renewed short-term weakness is almost inevitable and to an extent recent weakness is just reflecting this. There is, it should be mentioned, a mystery as this over production is not showing up nearly enough. You can see from the graph that the over production over the last 2 years has been over 1.5 million b/d. That should have pushed stocks up by 500 m barrels over a full year. A cursory inspection of the chart shown earlier of OECD stocks of crude and product shows no such thing has occurred. They have risen around 100m barrels only. To me this implies that the numbers we have on OPEC supply are overstated (the alternative is that the statistics on demand are understated). Anyway the implication of this is that the supply demand situation may be even tighter than it appears. Last month I quoted from a CSFB (Credit Suisse First Boston) piece entitled 10 Reasons Why 2005 Is Not Like I repeat the seven points I particularly agree with: The oil price is still well below its 1980 s inflation adjusted highs ($80-100) The [annual] increases in oil prices since 2000 have been well below those in 1974 and 1979 (In the 70s it went from $2.20 to $15 then $14 to $40) The global economy is less oil sensitive than in the 1980s (oil 33% lower share of GDP) Oil is still affordable for individual consumers (even now only 4% of US disposable income) Other demand centres are starting to reaccelerate (e.g. China, Asia ex China; Middle East) Refining is significantly less a threat to integrated oil earnings than in 1980s Sector valuations are already discounting a substantial correction in oil prices I am anxious, however, not to be too infected by the bull market over enthusiasm. And it is a worry that a belief in higher oil prices is becoming widely held (though maybe not in the oil majors yet). So, as stated last month, my reaction to the imponderables we currently face is to conclude that there are three main scenarios worth contemplating. (i) There is a pronounced demand and supply response and the oil price retreats to the mid $40s but is supported then by OPEC page 7

8 production cuts; (ii) the price comes back to $55 and then $50 $60 (or $45 $65) becomes the new normal trading range for several years; and (iii) that after averaging $55 in 2005 the price inexorable moves up through $65, $75 to say $85 over a several year period till we get to a natural long term price where demand is constrained sufficiently to match slow growing supply and properly encourage the development of alternative energy sources. As to probabilities I give them 30%; 40% and 30%. Current portfolio The invested fund at 30 th November 2005 was on a PER (Price to Earnings Ratio) (2005) of 10.5X with a median PER (2005) of stocks held of 9.6X and also on a PER (2004) of 16.2X. By comparison the S&P500 Index at was on a PER 16.7X(2005) and of 20.6X (2004) (Based on S&P500 EPS (Earnings Per Share) of 60.7 (2004) and Zacks estimates of 74.7 (2005) and (2006)). The discounts and the average WTI oil price in the relevant period is shown in the following table Fund PER 22.3X 16.2X 10.5X S&P500 PER 20.6X 16.7X 15.6X Discount -21% -37% Fund 2004 vs. -3% S&P WTI average $31.2/barrel $41.7/barrel $56.3/barrel (48 weeks) In assessing whether this picture represents good value one increasingly has to have a view on the long run oil price. If it is over $55 (let alone $65), and growing, then to me a 10.5X multiple looks to me cheap and there could easily be 48%/59% upside (taking the fund multiple to the market 15.6X/16.7X (2006/2005)). If the long run price falls back to $30-35 the PER of 22.3X would likely be expensive. There could be a 25%/30% downside on the same logic. And if the long run price is $42 say we are more or less fairly priced or maybe 10% expensive. page 8

9 Portfolio Holdings Our integrated stock exposure (c.28%) is principally comprised of midcap stocks (Conoco-Phillips; Occidental; Petro-Canada; OMV) and stocks we also categorise as E&P/Refining (Marathon; Amerada Hess). Mid caps continue to be less expensive stocks on PER and CFROI (Cash Flow Return on Investment) valuation bases although the gap is steadily narrowing. All four mid cap stocks held, and likewise the two E&P/Refiners, are on PERs between 7.4X and 10.9X This approach has led to underweighting titan stocks like Exxon Mobil (11.8X 2005) and BP (10.9X 2005). We do, however, hold Royal Dutch Shell (9.57X 2005) and Chevron (8.66X 2005). Our E&P and Oil Sands exposure (c.43%) gives us exposure most directly to a rising oil price. The stocks with oil sands exposure, Shell Canada, Encana, OPTI, Nexen and Canadian Oil Sands Trust are on PERs of between 12.1X and 15.4X (except OPTI which is a new project company). The higher multiples can be justified in that they have reserves with very long lives. The pure E&P stocks are all now in the US (Anadarko, Apache, Burlington, Devon, Pioneer Natural Resources, Plains Exploration and Whiting). Five of these stocks are on PERs between 8.12X and 10.77X Two of our new purchases are on higher PERs due to the effect of hedging losses. Their PERs fall into this range for 2006 as these fall out of the picture. We have exposure to a diverse group of Emerging Markets stocks. Some are mainly E&P focused (for example, PetroChina); others have significant downstream businesses. SASOL is a leader in coal/gas to oil technology. Three of our four principal Emerging Market stocks are on PERs (2005) of under 9X (Petrobras (7.2X), PetroChina (7.6X) and Sasol (8.9X)). Repsol is on 9.2X. Of other holdings Peabody is on a fairly high rating (26.15X) but gives exposure to steadily improving coal prices as higher oil prices drag them up and their earnings in 2006 are projected to grow by a third. Tesoro and Sunoco our independent refining companies are well positioned to benefit from current higher refining margins in the US. They are on 2005 PERs of 6.58X and 10.37X respectively. Lastly, Abbot (24.9X 2005), our only exposure to equipment and services, (although its original business North Sea production drilling - is declining), is well positioned in several markets with a good future, particularly the Former Soviet Union and Middle East. We continue to hold the view that equipment and service stocks are generally overvalued, notwithstanding likely strong growth next year. Overall, the Fund seeks to be well placed to benefit from rising share prices across the sector. In two of the three main scenarios outlined above ($55 oil and $55 rising to $85) we expect this to occur. The information contained in this report is from sources deemed reliable. No assurances can be made that all of the data contained is accurate. Investors should not rely on the data in this report in making decisions regarding individual stocks. Short term performance, in particular, is not a good indication of the Fund s future performance and an investment should not be made based solely on returns. Total return for the Fund reflects a fee waiver in effect and in the absence of this waiver, the total return would be lower. page 9

10 PER - Price to Earnings ratio is calculated by dividing current price of the stock by the company's trailing 12 months' earnings per share. As of November 30, 2005, the Fund did not hold any shares of Exxon Mobil or British Petroleum. The Fund s holdings, industry sector weightings and geographic weightings may change at any time due to ongoing portfolio management. References to specific investments and weightings should not be construed as a recommendation by the Fund or Guinness Atkinson Asset Management, LLC to buy or sell the securities. The Fund invests in foreign securities which will involve greater volatility, political, economic and currency risks and differences in accounting methods. The Fund is non-diversified meaning it concentrates its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. The Fund also invests in smaller companies, which involve additional risks such as limited liquidity and greater volatility. The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general. The MSCI World Index is an unmanaged index composed of more than 1,400 stocks listed on exchanges in the U.S., Europe, Canada, Australia, New Zealand and the Far East. They assume reinvestment of dividends, capital gains and excludes management fees and expenses. They are not available for investment. This information is authorized for use when preceded or accompanied by a prospectus for the Guinness Atkinson Global Energy Fund. The prospectus contains more complete information, including investment objectives, risks, charges and expenses related to an ongoing investment in the Fund. Please read the prospectus carefully before investing. Mutual fund investing involves risk and loss of principal is possible. Distributed by Quasar Distributors, LLC (12/05). Tim Guinness 12 December 2005 page 10

11 Historical Context Oil price (WTI) last 18 years Source: Bloomberg For the oil market, the period since the Iraq Kuwait war (1990/91) can be divided into two distinct periods: The first 8-year period was broadly characterised by decline. The oil price steadily weakened , rallied between , and then sold off sharply, to test 20 year lows in late This latter decline was partly induced by a sharp contraction in demand growth from Asia, associated with the Asian crisis, partly by a rapid recovery in Iraq exports after the UN Oil for food deal, and partly by a perceived lack of discipline at OPEC in coping with these developments. The last 6 1/2 years, by contrast, have seen a much stronger price and upward trend. There was a very strong rally between 1999 and 2000 as OPEC implemented 4 m b/d of production cuts. It was followed by a period of weakness caused by the roll back of these cuts, coinciding with the world economic slowdown, which reduced demand growth and a recovery in Russian exports from depressed levels in the mid 90s that increased supply. OPEC responded rapidly to this during 2001 and reintroduced production cuts that stabilised the market relatively quickly by the end of 2001 Then, in late 2002 early 2003, war in Iraq and a general strike in Venezuela caused the price to spike upward. This was quickly followed by a sharp sell off due to the swift capture of Iraq s Southern oil fields by Allied Forces and expectation that they would win easily. Then higher prices were generated when the anticipated recovery in Iraq production was slow to materialise. This was in mid to end 2003 followed by a much more normal phase with positive factors (China demand; Venezuelan production difficulties; strong world economy) balanced against negative ones (Iraq back to 2.5m b/d; 2Q seasonal demand weakness) with stock levels and speculative activity needing to be monitored closely. OPEC s management skills appeared likely to be the critical determinant in this environment. By mid 2004 the market had become unsettled by the deteriorating security situation in Iraq and Saudi Arabia and increasingly impressed by the regular upgrades in IEA forecasts of near record world oil demand growth in 2004 caused by a triple demand shock from strong demand simultaneously from China; the developed world (esp. USA) and Asia ex China. Higher production by OPEC has been one response and there is now some worry that this, if not curbed, may cause an oil price sell off. The spotlight prior to Katrina/Rita has been on OPEC and inventory levels worldwide. page 11

12 N American Gas price last 13 years (Henry Hub) Source: Bloomberg On the gas market, the price traded between $1.50 and $3/Mcf for the period This was followed by two significant spikes up to $8-10/Mcf, one in late 2000 and one early in The spikes were caused by very tight supply situations because there is an underlying problem with supply in the rapid depletion of North American gas reserves. On both occasions, the price spike induced a spurt of drilling which brought the price back down. More recently we have seen another period of very firm (over $5/Mcf) gas prices and another spike. North American gas prices are important to many E&P companies. In the short-term, they do not necessarily move in line with the oil price, as the gas market is essentially a local one. (In theory 6 Mcf of gas is equivalent to 1 barrel of oil so $40 per barrel equals $6.67/Mcf gas). It is a regional market more than a global market because Liquid Natural Gas imports cannot rapidly respond to increased demand because of the high infrastructure spending needed to increase capacity but that is slowly becoming less true as LNG infrastructure is put in place. page 12

13 Portfolio at 30 th November 2005 Stock Value ($'000) Country % of NAV PER Sector Mkt Cap $bn ROYAL DUTCH SHELL 3,536,908 UK Integrated CHEVRON TEXACO 3,517,459 US Integrated CONOCOPHILLIPS 3,416,879 US Integrated OCCIDENTAL PETE CORP 3,660,012 US Integrated PETRO-CANADA 3,884,855 Canada Integrated OMV AG 3,619,327 Austria Integrated MARATHON OIL CORP 3,515,186 US E&P/Refining AMERADA HESS CORP 3,467,439 US E&P/Refining PETROCHINA CO 3,566,212 China Emerging Mkts PETROLEO BRASILEIRO 3,746,820 Brazil Emerging Mkts REPSOL YPF SA 3,516,809 Arg/Spain Emerging Mkts SASOL 3,704,445 S Africa Emerging Mkts DRAGON OIL 85,612 FSU Emerging Mkts 0.97 IMPERIAL ENERGY 4,640 FSU 0.00 nm Emerging Mkts 0.31 AFREN 34,841 W Africa 0.03 nm Emerging Mkts 0.19 SHANDONG MOLONG PE 53,659 China Emerging Mkts 0.11 ENCANA 3,384,886 Canada E&P/Oil sands SHELL CANADA 3,679,041 Canada E&P/Oil sands CDN OIL SANDS TRUST 4,162,126 Canada E&P/Oil sands NEXEN INC 3,817,613 Canada E&P/Oil sands OPTI CANADA 3,430,366 Canada 3.39 nm E&P/Oil sands 2.59 SYNENCO 611,332 Canada 0.60 nm E&P/Oil sands 0.67 BURLINGTON RESOURCES 3,612,211 US E&P DEVON ENERGY CORP 3,550,295 US E&P APACHE CORP 3,588,376 US E&P ANADARKO PETE 3,556,896 US E&P PIONEER NATURAL RES 3,577,833 US E&P 7.93 PLAINS EXPL & PRODTN 3,775,296 US E&P 3.46 WHITING PETE CORP 3,199,981 US E&P 1.58 GREY WOLF 28,699 Canada E&P 0.16 GRANBY 22,523 UK 0.02 nm E&P 0.05 ABBOT GROUP 2,787,173 UK Eqt & Services 0.87 SUNOCO INC 3,752,692 US Refining TESORO 3,272,259 US Refining 4.78 PEABODY ENGR CORP 3,535,294 US Coal Mining STOCKS 100,675, PER CASH 407, TOTAL 101,083, PER page 13

14 Net Assets of Guinness Atkinson Global Energy Fund Since Launch Source: Investors Bank & Trust/ Guinness Atkinson page 14