Is Now the Time to Invest in the Energy Sector?
The energy sector has been mired in a historic decline of crude oil prices essentially since 2014. This has largely been due to an oversupplied market in the face of relatively flat global demand. Of the 90 million barrels of crude oil supplied globally each day, it is estimated that there are approximately 800,000 barrels of oversupply. Saudi Arabia, in particular, continues to oversupply an already oversupplied market. As a result of this oversupply condition (which could be exacerbated with additional supply being exported from the likes of Iran and the U.S.), oil prices hit a 12 year low early in 2016 and even traded below $30 per barrel at one point.
This has led many strategists to suggest that a bottom in oil prices has been established and that now may be the time to start investing again in the energy sector, and more specifically in oil related investments. Interestingly, oil has rallied in early March with Brent Blend (Brent) crude oil prices touching $40 a barrel. It may be helpful at this point to explain the differences between the two commonly quoted oil prices based upon information found on Investopedia.
• Brent Blend (Brent) – Roughly two-thirds of all crude contracts around the world reference Brent Blend, making it the most widely used marker of all. These days, “Brent” actually refers to oil from four different fields in the North Sea: Brent, Forties, Oseberg and Ekofisk. Crude from this region is light and sweet, making them ideal for the refining of diesel fuel, gasoline and other high-demand products.
• West Texas Intermediate (WTI) – WTI refers to oil extracted from wells in the U.S. and sent via pipeline to Cushing, Oklahoma. The fact that supplies are land-locked is one of the drawbacks to West Texas crude – it’s relatively expensive to ship to certain parts of the globe. The product itself is very light and very sweet, making it ideal for gasoline refining, in particular. WTI continues to be the main benchmark for oil consumed in the United States.
When assessing the oil market, we tend to focus more on Brent than WTI crude oil prices as we believe that Brent is a better indicator of worldwide oil prices than WTI.
While additional upside price potential for crude oil prices is certainly plausible, one could also present a valid argument that there is more potential downside risk to crude oil prices over the short term than there is upside potential. For example, while the much talked about agreement between a few of the world’s largest oil producing countries; Saudi Arabia, Russia and Venezuela, to curtail production could provide a boost to oil prices over the short term, the market has heard rumors of these talks before and they have yet to conclude with a definitive agreement. Additionally, many believe that the Organization of the Petroleum Exporting Countries (OPEC) may now step in sooner than some originally anticipated in 2016 to impose production caps on crude oil. This too would boost to oil prices over the short term if it were to become a reality. On the other hand, if neither of these events materializes over the next few months, investors may become dubious of any potential supply side relief and oil price bottoms could be tested again.
However, despite any additional, potential downward movements in oil prices, certain areas of the energy sector still have strong growth prospects in our opinion. While global demand for oil is relatively flat, natural gas is experiencing increased global demand and appears to have an attractive current valuation. Looking ahead, the Energy Information Administration (EIA) estimates that natural gas consumption will increase by 60%, on a global basis, by 2040. While natural gas prices can fluctuate based upon weather patterns, as we witnessed in the Northeast this winter season, additional factors supporting growth opportunities for natural gas moving forward, in our view, include the following:
• Natural gas is the cleanest burning fossil fuel and will continue to replace “dirty” coal energy sources in the months and years ahead
• The clean burning nature of natural gas is consistent with worldwide climate change initiative that was committed to during the December 2015 meetings in France
• Additional global demand for petrochemicals, which are used in the production of plastics for example, will continue to drive demands for natural gas worldwide
• While crude oil is a globally priced commodity, natural gas is a U.S. priced commodity and the U.S. is the largest producer and exporter of natural gas
While the U.S. has been the largest producer of natural gas in the World for quite some time, the U.S. has also become the largest producer of oil in the world on a more regular basis – overtaking both Russia and Saudi Arabia on the oil front likely at some point in 2014. The EIA has even reported that domestic production of crude oil will account for 63% of total supplies in 2016, up from just 38% in 2011. A major component of the drive towards American energy independence has been the fracking revolution. In fact, according to EIA, approximately 49% of oil production and 54% of natural gas output in the U.S. is due to fracking. For those not aware, hydraulic fracturing (a.k.a. “fracking”) has opened up new areas in the U.S. for both oil and gas development, with a particular focus on natural gas reservoirs such as shale.
Given the forward-looking optimism that many have for the energy sector, regardless of whether or not oil prices will move higher or lower over the short term, the rising domestic and international demand for clean burning fossil fuels, and the innovative fracking capabilities that exist on the North American continent, we believe that it is now time to consider investment strategies associated with the energy sector, diversified across both oil and natural gas and incorporating different components of the North American energy supply chain.
Disclosure: Hennion & Walsh is the sponsor of SmartTrust® Unit Investment Trusts (UITs). For more information on SmartTrust® UITs, please visit www.smarttrustuit.com. The overview above is for informational purposes and is not an offer to sell or a solicitation of an offer to buy any SmartTrust® UITs. Investors should consider the Trust’s investment objective, risks, charges and expenses carefully before investing. The prospectus contains this and other information relevant to an investment in the Trust and investors should read the prospectus carefully before they invest.