The Banyan Market Letter
The Politics of Oil Creates Opportunity
by MIKE BURNICK on June 29, 2011 Issue 23
In what appeared to be a political ploy, last week the International Energy Agency (IEA) said they planned to release 60 million barrels of crude oil from reserves … including 30 million barrels provided by Uncle Sam’s Strategic Petroleum Reserve.1
The official reason: According to the IEA, unrest in Libya has removed 132 million barrels of oil from world markets, which could lead to supply “tightness” that “threatens to undermine the fragile global economic recovery.”2
This surprise move sent crude oil prices tumbling last week, perhaps calling into question the bullish uptrend in energy for some investors. But this stunt could backfire on the IEA, potentially even leading to higher oil prices down the road.
At Banyan Partners, we’ve been bullish on energy sector stocks for some time; although we trimmed positions selectively in recent months as overall market volatility escalated. Nevertheless, we’re confident that rising global demand is a longer-term trend that will fuel higher prices ahead.
In fact, energy stocks have been among the best performing securities in the S&P 500 over the past 12 months, and we think this development will do little to derail the positive fundamentals for energy.
Why the IEA Move Could Backfire
We believe the market’s reaction will be temporary and relatively short term. And we view the current weakness as a fortunate opportunity for you to position your portfolio for long-term upside potential. Here’s our take …
Although the IEA succeeded in pushing oil prices lower in the short term, tapping oil reserves may have unintended consequences.
First, reserves are supposed to be used for true emergency disruptions. Eventually, they need to be repurchased, which could add upward pressure on prices over time.
Second, this move could undermine confidence in OPEC’s ability to cushion real emergency supply shocks using additional oil production.
Third, artificially pushing prices down may only encourage more demand and discourage future supply due to uncertain price volatility.
In addition, we believe fundamental supply/demand imbalances remain in place.
Fundamentals Support Energy Sector Investment
First, worldwide demand for oil has surged higher in spite of the uncertain economic outlook.
According to the IEA’s own data, global oil demand is expected to increase to 89.3 million barrels per day (mb/d) this year from 88 mb/d in 2010.3
Second, global crude oil supplies just aren’t keeping pace …
Global oil supply rose to just 87.4 mb/d in May. And non-OPEC oil supply growth has slowed dramatically this year to just 560,000 barrels a day — just half of 2010 levels.4
Third, Saudi Arabia, the king of OPEC oil supply, may be tapped out …
Most of Libya’s shortfall in oil production has been made up by Saudi Arabia so far. But Saudi production remains below 2008 peak levels in spite of global demand reaching new highs.
In fact, Saudi Arabia’s spare oil capacity is down about 25 percent from the peak last year, fueling fears that the king of crude may be tapped out!5
With oil prices hovering above $100 a barrel (before the IEA action) during a downshift in global growth … the key question is: What happens to crude prices when economic expansion picks up again?
Taking Advantage of the Secular Trend
At Banyan, we see this as an opportunity to reposition our energy sector holdings for our clients. The integrated oil producers are typically impacted the most by short-term volatility in crude prices, but there are many other ways to invest in the energy sector.
A case in point is Southwestern Energy (NYSE: SWN), a leader in natural gas production that is among the industry’s lowest cost producers. The company’s proven reserves soared 35 percent last year alone.6
Another opportunity is Peabody Energy (NYSE: BTU), the world’s largest private sector coal producer. With coal prices going through the roof, Peabody sells 90 percent of production under long-term contracts.7
Both of these companies have been on the Banyan Partners Buy List for some time. In our view, they are much less impacted by volatile crude oil prices short term, yet both offer terrific long-term appreciation potential.
Bottom line: We remain well positioned in the energy sector and advise investors to maintain appropriate exposure to the sector. It’s true that price volatility in the short run, often triggered by unpredictable (political) events, can be difficult to stomach. Over the longer term, the delicate global supply/demand balance doesn’t leave much room for stronger-than-anticipated demand … or for an unexpected supply shock that disrupts production. In other words, the secular trend toward higher energy prices remains intact.
Good investing,
Mike Burnick
Director of Client Communications
Banyan Partners, LLC
Banyan Partners and the advisory accounts that we manage may have option positions and/or long or short positions in the securities mentioned in this report and may purchase or sell such securities without notice. Please contact us for additional information.
The opinions expressed in this newsletter are subject to change without notice and do not represent a complete analysis of every material fact with respect to any company, industry or sector mentioned in this report. The strategies mentioned may not be suitable for all investors. This information has been prepared solely for information purposes and is not a solicitation or an offer to buy a security, instrument, or to participate in any trading strategy.
1 International Energy Agency, 6/23/11
2 Ibid.
3 International Energy Agency: Oil Market Report, 6/16/11
4 Ibid.
5 US Global Investors, 6/24/11
6 Standard & Poor’s, 6/25/11
7 Ibid.
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