Act now, supplies are running out!

Act now, supplies are running out!  While you most often hear that phrase during a late night television commercial (if you are still watching network television), it is the thought that crossed my mind watching financial news this week as crude oil prices (specifically the price of Brent which acts as the global oil benchmark price) hit $80 per barrel again. The bottom in Brent oil prices occurred in January 2016 at just under $29 per barrel and has been working its way back higher over the past two years.  Canceled projects impacted new production coming online to replace production declines in older fields.  OPEC, finally recognizing that their gambit with North American shale producers in 2014 had failed, decided to cut back their output in January 2017 and have since removed 1.8 million barrels collectively over the period since.  Recently, shifting geopolitical winds in Iran puts at risk at least some of the 2.4 million barrels per day exported which they have resumed since sanctions were lifted.  Finally, this week the International Energy Agency (IEA), released its most recent inventory report to reveal that levels are at three year lows and are about 1 million barrels below the trailing five-year average.  All of this has conspired to raise the commodity price by almost 50% in the past year (Brent oil price, the US benchmark West Texas Intermediate is up 45% over the same period).


Sadly, energy related equities have not kept pace.  The energy sector of the S&P 500 equity index is up only 12.4% in the trailing 1 year period – about a quarter of the return of the underlying commodity price.  Over a long period of time the statistical relationship of energy equities to the commodity price (typically called correlation) is more modest than you would expect despite being meaningfully positive (implying that, in general, energy equity and commodity prices tend to move in the same direction at the same time).  However, over a shorter period of time like the trailing one-year we are looking at, we would have expected prices to move more closely together since it was low oil prices (and the impact it caused to profitability) which triggered the equity decline.  Fundamentally, we have seen a significant recovery in the earnings at energy companies with first quarter results suggesting a near doubling from the prior year (93% growth according to Factset).  Investors are taking note and trying to catch up.  Quarter-to-date, the energy sector is up almost 16% while Brent oil is up only 12%.  Now, it will take a little more time and strong relative performance to get momentum moving.  At this point, the underperformance of the energy sector relative to other stocks has caused its weight within the S&P 500 to hover around 6% of the index.  With such a low weight and relatively poor performance, it has been easy for fund managers to ignore the sector. After a couple of strong quarters in total return, however, portfolio managers will be looking to snap these shares up fast lest they fall behind their beloved benchmarks.