Falling oil price weighs on sentiment
Invesco Perpetual’s Head of US Equities, Simon Laing (pictured), writes that there could be further short term pain before energy stocks could start to pick up
It’s very hard to tell whether sentiment is completely washed out in the oil sector. I attended a Goldman Sachs energy conference in the US last week which had attendance up 50% on last year suggesting there is still considerable investor interest (to be fair many were distressed debt investors). Furthermore, in their presentations, the majority of companies felt that any downturn would be short and that the second half of 2015 should be a better environment for oil prices.
Speaking directly to company management, you got a sense of the gravity of the situation. Management teams are shocked but not stunned – they are reacting very quickly. According to companies that have released capital expenditure (capex) budgets, most will be down 20-30% in 2015. But these figures were generally calculated at the beginning of December 2014 and given oil prices have fallen over $15 since then, companies admit these numbers could see further downward revisions. The goal is spending within cash flow.
The cuts to oil production are coming quickly and they are going to be big. The sheer momentum of capital spend means that production is still likely to rise in the first half of 2015 but it is very possible that at some time in 2016, US oil production will not have grown year on year.
Costs are falling faster than any previous down cycle. Companies are looking to reduce their costs anywhere between 20% to 30% with the pain being felt throughout the service industry cost structure. This is good news for oil company margins but suggests the reduction in production growth will be less than implied by the reduction in capex.
In a US stock market which is not brimming with value, this sector stands out if you think oil prices will recover over the next few years. That is our thesis, however, we believe we may need to suffer further short-term pain before we start to get rewarded. But the supply cuts are coming, the geopolitical risk is rising, oil prices have fallen over 50% and the US energy exploration and production sector has fallen over 30% from its mid-year peak. We have been here before and the scale of these falls is consistent with history. Contrary to what many seem to think, I believe that the sector will recover.