Three Reasons to Invest in Energy Long-Term
Hi, I’m Lou Gagliardi, an energy industry specialist who has ‘lived through the energy cycles.’ I would like to introduce myself to the readers at Energy Trends Insider. The topic of my column will be in energy finance and investment research. My goal will be to lay out the energy terrain to help you manage risk while enjoying the upside benefits of the sector’s long-term bullish trends. I will analyze and explain what energy industry trends you need to focus on to find long-term investment opportunities that balance risk and reward trade-offs.
But first a little bit about my career and experience.
I began my career doing project economics at Texaco for all facets of the energy value chain from upstream, downstream to midstream. I eventually segued to covering oil and gas companies at IHS Herold’s valuation shop. At Herold, I provided fundamental equity investment research. My core specialties run the entire energy value chain from oil, gas, and power markets to company coverage of Western multinationals, U.S. E&Ps, Canadian oil sands, national oil companies, refining, alternative energy, MLPs, pipelines, and oil service providers.
Over the years I have been interviewed by CNBC, the New York Times, Forbes, and the Financial Times, regarding Canadian oil sands, emerging markets, Enron and El Paso. I was featured in Robert Bryce’s book on the downfall of Enron, having notified clients of Enron’s financial inadequacies prior to the market’s awareness.
This past year, as crude price volatility has heightened, I have focused clients on industry infrastructure trends where “bottleneck” opportunities that “moves energy molecules” are providing long-term investment opportunities that have lower commodity risk and high dividend yields to provide support to the downside, like MLPs such as Magellan Midstream Partners (MMP) – up 11% with a 4% dividend yield since last October, and Plains All American Pipeline (PAA) – up 22% since last July with a 4.3% dividend yield. I also recommend companies that provide a “niche” service or product to the energy sector, such as Flowserve (FLS) that generates positive net free cash flow – up 22% since last August, SeaDrill Limited (SDRL) a specialty provider of deepwater drilling rigs that sports a roughly 9% dividend yield, and an MLP E&P BreitBurn Energy Partners (BBEP) – up 17% since recommended last August and boasts a nearly 9% dividend yield.
With more than two decades of industry experience in the oil patch, I will help you drill for opportunities all along the energy value chain from the upstream to the downstream, from E&Ps to oil service providers to pipeline MLPs. I will analyze industry trends, providing a multifaceted perspective in industry insight and analysis, and not only tell you what the trends mean, but who will be the winners and who the losers.
My investing approach builds upon a global commodity view, technical analysis supported by growth and momentum indicators, macroeconomic trends and solid fundamental analysis. I combine a top-down and bottom-up approach to investing in energy equities; linking equity, commodity, and currency markets with energy policy, to get a better understanding of the cross-currents that underlie share and market performance.
Successful investing in energy relies upon three key principles: getting the commodity right, getting the company right, and lastly getting the global macro picture right. Never has that core tenet been as important in energy as today, particularly with the heightened global economic uncertainty and accentuated market and commodity swings over the near term. However, I do see lucrative investment opportunities over the long-term horizon for energy investors.
Indeed, the long-term global energy view is best captured in understanding three structural long-term trends that I do not see abating:
- Constrained Global Resource Supply: increasing demand from developing nations will outstrip available global supply.
- Continued Economic Growth in Emerging Markets will be spurred by faster population growth than in OECD nations.
- Global Inflationary Pressures will be fueled by increasing monetary stimulus.
All three factors are bullish long-term catalysts for higher crude prices. Indeed, constrained global resource supply is the most critical tailwind that will drive oil prices higher. This point is driven home in the chart below: when global oil production from 2000 onward began to fall below 95% of global consumption, crude prices moved dramatically higher. Over the long-term I do not see this scenario abating, rather I see it intensifying.
Since 2000 emerging markets have driven global GDP growth.
Excessive monetary stimulus provides an additional support to higher crude prices from 2000 onward.
According to the IEA, roughly 80% of the world’s population resides in the developing world, i.e., Asia, Africa, Latin America and the Middle-East, which grew from 1990 to 2008 at an annual rate of 2.1% and is projected to grow at 1.4% per annum to 2025. Compare this to OECD nations in North America and Europe, where population grew at a more moderate 0.7% from 1990 to 2008 and is expected to remain at that rate through 2025.
Markets in 2013 will continue to be preoccupied with “economic uncertainty,” i.e., sovereign debt woes in Europe, a ballooning U.S. deficit and overall a precarious global financial system that has stymied global economic growth and spawned excessive monetary stimulus to jump-start flagging economies, but in reality has fueled longer-term inflationary expectations. The net result has been greater global market and currency volatility that in turn has heightened oil price volatility. Against this backdrop of high market beta, with energy stocks nearly 90% positively correlated to oil prices, which in turn are highly negatively correlated to the U.S. dollar, managing the downside is critical to trading energy stocks.
In the near-term I will trade around volatile crude prices by focusing on a select few defensive energy stocks that have a high dividend yield and upside potential to maximize returns; companies that are currently exhibiting relative strength and growth momentum.
However, the investing foundation of my fundamental methodology will rest on six “quality” attributes: links along the oil & gas value chain of “Resources to Production to Cash Flow to Value.”
- Low cost producers to strengthen the P&L;
- Companies with deep resources to grow future production;
- High growth prospects to accelerate cash flow;
- Strong balance sheets with low debt expense to invest through the cycles;
- High net cash flow (NCF) to feed future growth prospects;
- Companies that trade at a discount to net asset valuation to optimize the upside.
Stay tuned as I keep you abreast of the latest industry trends to drill for the best long-term investment opportunities.