Investors who bought up energy stocks or crude oil futures a few months ago when it seemed like petroleum prices had bottomed are likely feeling some pain after the late-August drop in the equities market.
Greater concerns about China’s economy, despite the government’s attempts to stabilize its sinking stock market, spurred both a late-August sell-off in energy prices and the stock market.
Crude oil has suffered from oversupply for at least a year now, and the situation hasn’t improved despite hopes earlier in the year that a drop in the number of U.S. oil rigs would mean less output. Although the count is down versus a year ago, U.S. oil rig counts grew in August and pushed oil under $40 a barrel.
Additionally, the Organization of Petroleum Exporting Countries is routinely pumping oil above its daily stated quota. OPEC pumped an average of 31.5 million barrels a day in July, the most in three years.
All this oversupply is hanging over energy prices and the sector, including oil-producer stocks and even some master limited partnerships. MLPs are complex, alternative investments designed to give buyers a way to invest in U.S. energy infrastructure, whether it’s energy producers or companies that carry the oil via pipeline to a refining destination or a storage tank.
Although the so-called midstream MLPs that focus on companies building infrastructure projects are supposed to be immune from the price of oil since they often lock in long-term contracts based on the volume of oil moved, they, too, are getting tarred and feathered by the drop in energy prices.
The renewed sell-off spurred debate about whether this is the time to step up and buy or wait. Mark C. Scalzo, managing partner and chief investment officer at Validus Growth Investors, says he’s wary about wading in now. “We do not see moves higher as sustainable until we see signs of real demand growth [from China and Europe], which is very unlikely in the near term,” Scalzo says.
Many miners and drillers will have substantial write-downs in their oil-reserve levels at year end, which may not be factored into the price of these equities, Scalzo says, and that means it’s hard to judge future earnings.
Others, like Douglas Guffy, senior portfolio manager focusing on energy stocks for the Baird Mid Cap Growth Equity fund, says despite current carnage, energy is a secular growth story. He adds that world gross domestic product growth will drive the asset class for a long time.
“China and India … they’re not going away. The demand for energy need is going to continue to increase,” he says. “There will be cyclical moments where that gets out of whack. When you arrive at moments like we have today in the market, if you have a view where you are secularly, then it makes stepping into a cyclical moment like you see now easier to do. We look at this and say from a secular point of view, severe price retreats should be an opportunity for us.”
Mike Ciccarelli, commodity and stock trader at Briefing.com, says people who want to buy energy investments should do homework now, keeping in mind that more losses are possible.
“Clearly Wall Street is still struggling to say that oil prices have bottomed,” he says. “For any oil and gas plays, you want to make sure they have strong balance sheets so they can come out OK.”
Eric Angeli, investment executive at Sprott Global Resource Investments, also warns investors to be careful. In the big picture, though, he says there are some bargains. “Make no mistake about it, we’re not going to stop using oil and energy inputs,” he says.
For people interested in a simple way to invest in energy infrastructure, Angeli recommends an exchange-traded fund, the Alerian MLP ETF (ticker: AMLP), which is the biggest and most liquid MLP fund. “It has low volatility and good income,” he says.
Investors like MLPs because of their rich distributions. For example, the Alerian fund has a yield of 8.63 percent, versus the 10-year Treasury note yield of about 2 percent. However, over the past 12 months, it’s down about 18 percent.
Ciccarelli says when looking at MLP funds, check if any of the MLPs the fund holds have cut dividends, as has been the case for some upstream MLPs that focus on oil drilling and are therefore influenced greatly by oil prices.
Mark Travis, manager of the Intrepid Capital Fund, said people who want to buy into the energy sector now must consider the price of a company’s stock and the firm’s debt load. That will become particularly important if the Federal Reserve raises interest rates later this year.
“I’d be very careful about their balance sheet; I wouldn’t make a herculean assumption … An equity that has commodity exposure is a bit like Tabasco sauce — a little goes a long way. I wouldn’t have more than 2 percent aggregate weight in a portfolio,” he says.
Travis says he shies away from MLPs because of their complexity. Instead, his fund owns oil and gas company Unit Corp. (UNT). He says he likes that the firm has its own distribution pipeline and an experienced management team.
For investors with a high risk tolerance, Ciccarelli says one of his favorites is oil and gas company Pioneer Natural Resources Co. (PXD), citing strong management with strong hedges. Hedges are investments companies make to lower the risk of prices moving against them.
“For this year, they have 90 percent of their oil hedged, and for 2016, they 75 percent hedged,” he says.
Guffy says he looks at companies that have resources in the Permian and Eagle Ford basins, such as Diamondback Energy (FANG), an independent oil and natural gas company.
Steve Wruble, chief investment officer of RiskX Investments, says turmoil in the markets could last longer, but for investors seeking to pick up bargains, it’s worth looking for clues for possible market turnarounds.
“No one knows how long the current conditions may last. Watch for positive economic news. If China straightens out, that will make people feel better,” he says.
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