Energy stocks outpace crude
Energy investors appear to be getting ahead of themselves, judging by the premium energy stocks are demanding over the price of oil.
While U.S. crude is down by more than 10 per cent from its highest close this year on June 8, the S&P 500 Energy Index is off less than one per cent since, and the S&P/ TSX Energy Index of Canadian producers has gained 3.8 per cent. The disconnect implies that, unless oil prices are set to rise sharply, equities are overpriced.
“Oil prices are telling you it’s not good and yet equity investors are finding all kinds of different reasons to stay in the stocks,” said Martin Pelletier, managing director and fund manager at TriVest Wealth Counsel in Calgary.
His firm closed its energy fund a month ago after the spring oil rally and has taken its clients’ individual energy holdings almost to zero, he said. “The upside is less than the downside risk.”
Crude has fluctuated on mixed signals since declining more than 20 per cent into a bear market and closing below $40 a barrel in the first week of August. A rise in drilling rigs in the U.S., heading into a period of seasonal demand weakness, is fomenting negative sentiment that a supply glut will persist, while indications Saudi Arabia is prepared to discuss stabilizing markets are supporting prices.
The two-year rout has eroded cash flow for producers globally, forcing them to shelve drilling, cut workers and squeeze costs to survive. The earnings picture has yet to improve. The most recent quarterly results for North American energy companies shows 84 per cent had lower revenues than a year ago and 78 per cent had worse earnings, according to data compiled by Bloomberg.
As West Texas Intermediate crude hovers around US$45 a barrel, the stocks of large oil and natural gas producers are implying $65, and smaller companies are pricing in oil above $55, according to Robert Fitzmartyn, an analyst at FirstEnergy Capital Corp. in Calgary. That disparity can be typical, as energy stocks don’t always track down or up in line with oil and trailed behind the commodity during this year’s spring rally, he said.
“For the most part, we’d probably say a lot of these stocks are pretty full right now,” as investors are focused on longer-term expectations for an oil price recovery, Fitzmartyn said.
Year to date, the S&P/TSX Energy Index is up 23 per cent, in line with the rise in U.S. crude prices, while the S&P 500 Energy Index has risen 14 per cent. The best performers have been gas stocks, reflecting a 19 per cent gain for the power-plant fuel since the start of May.
Analysts have so far avoided cutting their price targets for stocks on the S&P/TSX Energy Index amid oil’s recent weakness, unlike in the past. The recommendations are at their highest point this year, according to data compiled by Bloomberg. That may be because the prevailing view is that oil prices will rise.
Investors buying energy stocks think there’s still room for the shares to rise if oil indeed rebounds, said Laura Lau, senior vice-president and senior portfolio manager at Brompton Group in Toronto. Lau is adding energy holdings to her resource fund, she said, counting herself among those who see oil’s current weakness reflecting lower seasonal demand and betting prices will be higher toward the end of the year.
“They saw in the beginning of the year what happens when you’re underweight and these stocks explode. You wanna be there,” Lau said. “It’s not a bad idea to start adding some torque to the portfolio.”