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Energy Brief - April 2005April 28th, 2005 by Tim Guinness Guinness Atkinson Funds
Oil MarketThe oil price continued to be surprisingly firm in March. It rose from $51.49 at the beginning of the month to close on March 31 at just under $54.00. There was a marked spike in the first week of the month, with the price closing at $54.59 on March 9, and the price, after a small correction, continued to increase in the run-up to the OPEC (Organization of Petroleum Exporting Countries) meeting in Isfahan, Iran on the 16 of the month, closing at a record $57.50 on the following day. This strength was a major factor in OPEC's decision to increase production by 500,000 b/d to 27.5 million b/d at its meeting. Oil price (WTI - West Texas Intermediate) 27 months from 1st January 2003 to 6th April 2005
The implications of this decision, coupled with rising US Department of Energy Inventory figures published on March 24 and 31, brought the price of WTI back down to $53.99, significantly closer to the $40 - $50 level which the Saudis are increasingly hinting they consider appropriate. The focus of attention during the month was very much on the big picture drivers of supply and demand in the oil market whether or not these forces were supportive of a $50 + oil price. Thus the surge in the oil price over the first 10 days of the month reflected:
In the second week focus turned to what the IEA (International Energy Agency) might say in its March IEA Report. This, published two days before the OPEC meeting, contained the following: 1. A forecast of further increases in world demand (up 0.3 million b/d from 84m b/d (barrels per day) (February forecast) to 84.3m b/d) due to
2. An upwards forecast of the call on OPEC. Viz that it should produce 28.6 million b/d on average in 2005 (revised up from 28.4m b/d in February). This moved towards the higher numbers from Simmons International, the Houston Energy investment bank, I gave you last month. The main difference is in NGLs ? here the IEA looks more reasonable. At the moment 29m b/d looks a fair compromise. (OECD - Organization for Economic Cooperation and Development.)
Then on March 16 all eyes turned to the OPEC meeting. The major outcomes of the meeting in Isfahan, Iran on March 16/17 were
Since the talks, other price supporting events which have had to be absorbed by the oil market included:
However, despite all of this, the price dropped $3.51 pb WTI between the talks and the end of the month ($57.50 - $53.99). Factors causing this included the following:
Since the end of the month we have seen a move up in the oil price back over $57 inspired by a Goldman Sachs report that a "super spike period may be upon us" which it argued could drive oil prices towards $105/bbl, but this has been relatively short lived and as I write the WTI price is back at $53.30 where it was in the first week of March. OPEC meet again for talks on June 7. Inventories OECD total crude and product inventories ( my preferred measure of looseness or tightness in the market) after moving down in December (reversing the rise seen earlier in the autumn) ( see chart below) remained little changed in January. By this measure they are at the halfway point between loose and tight. Many commentators are arguing that this measure of tightness/looseness is too simplistic and that stocks are better presented in terms of days of demand. On that measure stocks are still reasonably tight as 2.6bn/50m b/d = 52 days of OECD demand. OECD Stocks of crude and Product by month Jan 1998 - Jan 2005
Alternatively some other commentators are arguing that now the world is so much nearer full production capacity then more stocks are needed as a buffer for disruption. Thus they argue that drawing price conclusions from this measure may no longer work. Speculative positions. Another important feature of the month was that noncommercial (e.g. hedge funds and other investors) net long position on NYMEX increased further as the following chart shows. Non Commercial net futures positions ? Nymex crude oil contract Nov 2003 ? 29 Mar 2005
The long position expanded to its highest level at least since Nov 2003 at over 88,000 contacts. Obviously this can unwind and of itself drive the price down $5-$7. In March the gas market was very firm. Henry Hub averaged $6.97 (vs$6.16 in February) and traded between $6.52 and $7.44 ($5.88 and $6.64 in February). Stocks at end March 1239 bcf are still well above (206 bcf) the 5-year average but rather less than a month ago when they were 359 bcf above. Henry Hub Gas price 24 months 31st March 2003 ? 6th April 2005
Oil and Gas EquitiesMarch saw energy stocks traded sideways and down. The main index of oil stocks, the MSCI World Energy index, was down 3% (by comparison the broad market, as reflected by the S&P500, fell 1.9%). Performance ReviewOver the month under the review, the Fund outperformed the MSCI World Energy Index, falling only 0.5%. Within the Fund, March's stronger performers were Petro Canada (reversing last month's weakness), Encana, Nexen, Devon and Unocal. Poorer performers were Petrobras, OMV, Amerada Hess, Chevron Texaco and Royal Dutch Shell.
Performance data quoted represent past performance and does not
guarantee future results. The investment return and principal value of
an investment will fluctuate so that an investor?s shares, when
redeemed, may be worth more or less than their original cost. Current
performance of the Fund may be lower or higher than the performance
quoted. Performance data quoted to the most recent month end may be
obtained by calling (800) 915-6566 or visiting our website at
www.gafunds.com. Energy Fund vs. S&P500 and MSCI Energy Index Since launch to March 31, 2005
Buys/SellsWe bought OPTI, a Canadian company that is developing a SAGD project in partnership with Nexen. There were no other transactions during the month (other than for investing flows). The following table shows the asset allocation at various recent dates since end June 2004
Market OutlookDespite concerns that the oil price will fall to $45 in the next few weeks and despite strong moves already we continue to share the current market optimism for the energy sector. Study of the following table compiled from data in the latest IEA monthly oil report will be quite helpful in understanding what is going on. Estimated Annual World Oil Demand Growth 2000 ? 2005
Note in particular how the call on OPEC has jumped by 3.5m b/d in the 2003 ? 2005 period. This jump is a key driver behind the current oil price strength. The call on OPEC has taken OPEC production to within 1 or 2million barrels of believed OPEC capacity. This strengthens hugely OPEC's ability to secure a higher price for its oil. And this in turn has been greatly assisted by the fact that the experience of a "doubled" oil price (i.e. $50 recently vs. $25 (the real level 1986 ? 2002)) has had little adverse impact on the world's economy. I show below a chart of recent OPEC production levels on which the call on OPEC numbers are shown by the horizontal bars. OPEC10 plus Iraq Production 1999 ? Feb 2005 (?000 barrels/day)
And we can note that in 2006 if the non OPEC supply growth is around 1m b/d and demand growth is 2m b/d we will need 30m b/d of OPEC oil. On the other hand no careful observer could fail to see that just now OPEC appears to be overproducing by 1m b/d and I continue to caution that a period of short-term weakness is still quite likely. Indeed, when I reflect on the latest OPEC10 increase to 27.5m b/d and Saudi adding further that it was turning the taps on, I find myself puzzled at the continuing strength of the oil price. Particularly as I think it underlined that for political reasons Saudi Arabia really does want a price below $50. So what is going to happen next? I think oil will hit $45 in the next 2 months. How likely ? 60/40. Turning to a slightly longer time horizon, we are increasingly confident that the US and China along with the rest of emerging Asia and the Middle East and the FSU are going to continue to provide robust demand growth. We accept it will likely fall back from the 2004 level which was exceptional but we note that very recently Chinese authorities have been warning of the rapid worsening in power shortages which will support oil imports to run back-up generators. In the medium term, growth in car ownership is going to be hard to stop and with that will come high rates of oil consumption growth for 10 ? 20 years. We also see an emerging consensus that the global economy can cope with oil prices at much higher levels than previously thought. We also believe the impending difficulty of growing non-OPEC supply is considerable. Therefore over the medium to long term OPEC can, and likely will, pursue policies which mean oil will trade considerably above the old $22-28 target range, probably over $40 WTI now and we would not be remotely surprised to see a new target range within a few years of $50 -60 which is where the price in real terms averaged for 12 years 1974 -85. Looking at the big picture, I remain ever more convinced that the medium term outlook is for a decisive break with the $25 oil of the 1986- 2000 period and a shift back to the $55+ world of 1975 ? 1985. Meanwhile, the odds on a sizeable dip are reducing as OPEC starts taking the necessary action and Russian production growth slows. The last matter to mention is the Goldman Sachs oil price super spike. At the heart of the Goldman analyst Arjun Murti's argument is that US gasoline prices need to get up to $4 + per gallon to bring overall gasoline spending as a % of GDP to the levels in the late 1970s early 1980s. That that is required if we are to damp gasoline demand enough to balance oil demand and supply. Also, a $4+ gasoline price requires a $105 - $135 oil price. This is an extract from the table in his report: showing how high the gasoline price has to get to push gasoline demand up towards the 4.5% average of 1980 - 81.
I think he was fearful he would be seen as over the top so he never mentioned $135/bbl oil but that's the logical conclusion of his report! The fund at 31st March 2005 was on a PER (Price to Earnings Ratio) (2004) of 13.0X (26% below the S&P500 which is on 17.75X (2004) if earnings are 66.5(Zacks) and the S&P 500 is 1180 (31st March 2005)). (nb it is 21% below the 2005 S&P500 PER of 16.5X) There is of course an issue as to what is the right level for energy stocks to trade on. By way of interest this PER of 13.0X reflects a year when the oil price (WTI) averaged $41.7/b and the gas price Henry Hub $5.80/mcf (thousand cubic feet). I have done an exercise to calculate the PER of the portfolio at end February prices on the 2003 earnings of the stocks I hold ? it is 17.5X. This was a year when WTI averaged $31.2/b and H Hub $5.44/mcf. In assessing whether this represents good value one increasingly has to have a view on the long run oil price. If is over $40 (let alone $55), and growing, then to me a 13.0X multiple still looks modest. If the long run price falls back to $30 or $35 this is increasingly fair value but it doesn't seem the downside is that great. Of course there would be considerable downside if the oil price traded back down to $25. There is no such thing as a free lunch. Portfolio HoldingsOur integrated stock exposure (c28%) is principally comprised of midcap stocks (Conoco-Phillips; Occidental; Petro-Canada; OMV) and stocks we also categorise as E&P/Refining (Marathon; Amerada Hess). Mid caps continue to be less expensive stocks on PER and CFROI (Cash Flow Return On Investment) valuation bases. All four mid cap stocks held, and likewise the two E&P/Refiners, are on PERs between 9.3X and 12.6X 2004 . This approach has led to underweighting titan stocks like Exxon Mobil (15.3X 2004) and BP (15.5X 2004). We do, however, hold Royal Dutch Shell (10.4X 2004) and Chevron Texaco (9.5X). Our E&P and Oil Sands exposure (c50%) gives us exposure most directly to a rising oil price. Of the oil sands stocks, Encana, Shell Canada, OPTI and Canadian Oil Sands Trust give the most immediate exposure to current production of oil from oil sands. The PERs 2004 of these companies (except OPTI which is a new project company) are between 14.4X and 21.7X. This is justified in that they have reserves with very long lives. The other two - Canadian Natural Resource and Nexen - also give exposure to Canadian gas, a likely beneficiary of medium-term supply shortages. They are more like pure E&P stocks as their oil sands projects are in the future. The pure E&P stocks include 6 in the US (Anadarko, Apache, Burlington, Chesapeake, Devon and Newfield), and one UK (Venture Production). All of these stocks (including Canadian Natural Resources and Nexen) are on PERs between 10.9X and 14.5X 2004, with the exception of Venture Production, which trades on a higher multiple (31.0X) because it is expanding its production in the North Sea from legacy fields very rapidly, particularly of North Sea gas where the price has firmed markedly. We have exposure to a diverse group of Emerging Markets stocks. Some are mainly E&P focused, for example, Petrochina, others have significant downstream businesses. SASOL is a leader in coal/gas to oil technology. Two of our four principal Emerging Market stocks are on PERs (2004) of under 10X ( Petrobras (6.9X), and Petrochina (8.2X)). Repsol, and SASOL are on PERs in the low teens. Of other holdings Peabody is on a fairly high rating (33.1X) but gives exposure to steadily improving coal prices as higher oil prices drag them up and their earnings in 2005 are projected to more than double. Lastly, Abbot (26.5X 2004), our only exposure to equipment and services, (although its original business ? North Sea production drilling - is declining), is well positioned in several markets with a good future, particularly the Former Soviet Union and Middle East and yet sits on a sizeable valuation discount to its US counterparts. It guided expectations for 2004 lower in January (due to slower than projected North Sea results), which knocked the price, but it has nearly recovered this since. We continue to hold the view that equipment and service stocks are overvalued, notwithstanding likely strong growth next year. Overall, the Fund seeks to be well placed to benefit from rising share prices across the sector, which we expect to occur if, as forecast, the oil price is destined to stay in a much higher trading range than we had become used to in the last 18 years. The information contained in this report is from sources deemed reliable. No assurances can be made that all of the data contained is accurate. Investors should not rely on the data in this report in making decisions regarding individual stocks. Short term performance, in particular, is not a good indication of the Fund?s future performance and an investment should not be made based solely on returns. Total return for the Fund reflects a fee waiver in effect and in the absence of this waiver, the total return would be lower. PER - Price to Earnings ratio is calculated by dividing current price of the stock by the company's trailing 12 months' earnings per share. As of March 31, 2005, the Fund did not hold any shares of Exxon Mobil or British Petroleum. The Fund?s holdings, industry sector weightings and geographic weightings may change at any time due to ongoing portfolio management. References to specific investments and weightings should not be construed as a recommendation by the Fund or Guinness Atkinson Asset Management, LLC to buy or sell the securities. The Fund invests in foreign securities which will involve greater volatility, political, economic and currency risks and differences in accounting methods. The Fund is non-diversified meaning it concentrates its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. The Fund also invests in smaller companies, which involve additional risks such as limited liquidity and greater volatility. The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general. The MSCI World Index is an unmanaged index composed of more than 1,400 stocks listed on exchanges in the U.S., Europe, Canada, Australia, New Zealand and the Far East. They assume reinvestment of dividends, capital gains and excludes management fees and expenses. They are not available for investment. This information is authorized for use when preceded or accompanied by a prospectus for the Guinness Atkinson Global Energy Fund. The prospectus contains more complete information, including investment objectives, risks, charges and expenses related to an ongoing investment in the Fund. Please read the prospectus carefully before investing. Mutual fund investing involves risk and loss of principal is possible. Quasar Distributors, LLC (04/05).
Tim Guinness
The information contained in this report is from sources deemed reliable. No assurances can be made that all of the data contained is accurate. Investors should not rely on the data in this report in making decisions regarding individual stocks. Short term performance, in particular, is not a good indication of the Fund's future performance and an investment should not be made based solely on returns. Total return for the Fund reflects a fee waiver in effect and in the absence of this waiver, the total return would be lower. PER - Price to Earnings ratio is calculated by dividing current price of the stock by the company's trailing 12 months' earnings per share. As of January 31, 2005, the Fund did not hold any shares of Exxon Mobil or British Petroleum. The Fund's holdings, industry sector weightings and geographic weightings may change at any time due to ongoing portfolio management. References to specific investments and weightings should not be construed as a recommendation by the Fund or Guinness Atkinson Asset Management, LLC to buy or sell the securities. The Fund invests in foreign securities which will involve greater volatility, political, economic and currency risks and differences in accounting methods. The Fund is non-diversified meaning it concentrates its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. The Fund also invests in smaller companies, which involve additional risks such as limited liquidity and greater volatility. The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general. The MSCI World Index is an unmanaged index composed of more than 1,400 stocks listed on exchanges in the U.S., Europe, Canada, Australia, New Zealand and the Far East. They assume reinvestment of dividends, capital gains and excludes management fees and expenses. They are not available for investment. This information is authorized for use when preceded or accompanied by a prospectus for the Guinness Atkinson Global Energy Fund. The prospectus contains more complete information, including investment objectives, risks, charges and expenses related to an ongoing investment in the Fund. Please read the prospectus carefully before investing. Mutual fund investing involves risk and loss of principal is possible. Quasar Distributors, LLC (02/05). Historical ContextOil price (WTI) last 18 years
For the oil market, the period since the Iraq Kuwait war (1990/91) can be divided into two distinct periods: The first 8-year period was broadly characterised by decline. The oil price steadily weakened 1991 - 1993, rallied between 1994 ?1996, and then sold off sharply, to test 20 year lows in late 1998. This latter decline was partly induced by a sharp contraction in demand growth from Asia, associated with the Asian crisis, partly by a rapid recovery in Iraq exports after the UN Oil for food deal, and partly by a perceived lack of discipline at OPEC in coping with these developments. The last 6 1/4 years, by contrast, have seen a much stronger price and upward trend. There was a very strong rally between 1999 and 2000 as OPEC implemented 4 m b/d of production cuts. It was followed by a period of weakness caused by the roll back of these cuts, coinciding with the world economic slowdown, which reduced demand growth and a recovery in Russian exports from depressed levels in the mid 90s that increased supply. OPEC responded rapidly to this during 2001 and reintroduced production cuts that stabilised the market relatively quickly by the end of 2001. Then, in late 2002 early 2003, war in Iraq and a general strike in Venezuela caused the price to spike upward. This was quickly followed by a sharp sell off due to the swift capture of Iraq's Southern oil fields by Allied Forces and expectation that they would win easily. Then higher prices were generated when the anticipated recovery in Iraq production was slow to materialise. This was in mid to end 2003 followed by a much more normal phase with positive factors (china demand; Venezuelan production difficulties; strong world economy) balanced against negative ones (Iraq back to 2.5m b/d; 2Q seasonal demand weakness) with stock levels and speculative activity needing to be monitored closely. OPEC's management skills appeared likely to be the critical determinant in this environment. By mid 2004 the market had become unsettled by the deteriorating security situation in Iraq and Saudi Arabia and increasingly impressed by the regular upgrades in IEA forecasts of near record world oil demand growth in 2004 caused by a triple demand shock from strong demand simultaneously from China; the developed world (esp USA) and Asia ex China. Higher production by OPEC has been one response and there is now some worry that this, if not curbed, may cause an oil price sell off. The spotlight is now on OPEC and inventory levels worldwide. N American Gas price last 13 years (Henry Hub)
On the gas market, the price traded between $1.50 and $3/Mcf for the period 1991 - 1999. This was followed by two significant spikes up to $8-10/Mcf, one in late 2000 and one early in 2003. The spikes were caused by very tight supply situations because there is an underlying problem with supply because of the rapid depletion of North American gas reserves. On both occasions, the price spike induced a spurt of drilling which brought the price back down. More recently we have seen another period of very firm (over $5/Mcf) gas prices. North American gas prices are important to many E&P companies. In the short-term, they do not necessarily move in line with the oil price, as the gas market is essentially a local one. (In theory 6 Mcf of gas is equivalent to 1 barrel of oil so $40 per barrel equals $6.67/Mcf gas). It is a regional market more than a global market because Liquid Natural Gas imports cannot rapidly respond to increased demand because of the high infrastructure spending needed to increase capacity. Portfolio at 31st March 2005
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