Wednesday, 31 July 2013

Energy Production - The sector investors seem to forget

The Wealth Advisory (Marbella)

UK ENERGY production is in the headlines with the proposed tax cut for shale gas firms and the use of the controversial fracking technique.

The Wealth Advisory (Marbella) Financial News

The government’s plans would make the UK the most generous tax regime for shale gas production in the world. The UK government is pinning great hopes on benefiting from possible large resources of shale gas.

The much-hyped US shale gas glut is ending, while emerging economy gas demand is exploding.

China’s natural gas demand is growing at 16% pa.

The seven-year growth in US production from fracking was absorbed initially until, in late 2011, supply overwhelmed demand.

The industry reacted in classic fashion: the gas rig count has more than halved and electric utilities switched from coal to gas.

This will rebalance the market.

The only issue is timing, and the signs are good: 2012’s huge storage overhang has now disappeared.

Elsewhere, natural gas prices have remained firm – 3x the US price in the UK and 5x in Japan.

China has grown its gas consumption by 17% pa since 2000.

Its gas consumption is 20% of the US, but it consumes 3.6x the amount of coal.

It shows every sign of growing its gas demand 4x in the next ten years.

As one of the cheapest sectors in the MSCI World index, energy could be ripe for a re-rating and may merit a closer look for global equity investors. The global oil market is relatively balanced.

Under the surface, emerging economy demand is growing powerfully, driven by accelerating demand for motor vehicles as four billion people move into the ‘buying’ income strata.

Emerging economy oil demand should grow each year offset by marginal OECD demand decline.

There is an impression shale oil will meet this demand growth and more.

This is misplaced over-enthusiasm, however.

Shale is just like the development of the Gulf of Mexico, North Sea and Alaska in the 1980s after the 1970s price hike.

But with one difference: oil demand from the OECD economies had exploded from 1950 to 1973.

They were ending a 25-year journey adopting the motorcar; impetus faded and demand naturally corrected as prices jumped.

Now it is a different era however.

China’s demand for oil per capita has not even reached that of the OECD in 1950.

There are 20 years of unrelenting oil demand growth to come while China’s vehicle fleet moves from 100m now to 400m by 2030, with India and others following behind.

Looking ten years forward, there will be muted supply growth.

Any imbalances will be met by OPEC adjusting their production.

Will Riley, co-manager of the Guinness Global Energy fund believes that energy equities have underperformed because these factors are misunderstood.

On traditional metrics of P/E, price-to discounted cashflow or enterprise value to reserves, many energy companies are at historically low levels.

The 2012 P/E ratio of his fund at 31 May is 10.2x versus 16.8x for the S&P 500.

The dislocation over the past 24 months between the oil price and energy valuations is striking and suggests investors should not overlook the undervalued opportunities in the sector.

Reproduced from an article that appeared in The Liverpool Daily Post.

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