One of the best performing sectors in the equity market recently has been energy. Since the end of November, mid-stream pipelines (Master Limited Partnerships – MLPs) are up over 19% through last Friday’s close. We believe that these gains represent the early stage of a long bull market in energy investments for the following reasons:
- Business expansion in the United States due to corporate tax cuts.
- Energy stocks lagged the price of oil last year as energy stocks were negative while the price of oil rose more than 15%.
- This sector is cheap. Energy stocks are the only US equity sector that is selling below their 20+ year average P/E ratio. Almost every other sector is selling near their historical high.
- Better margins. Saudi Arabia tried to quash the US energy industry by forcing the price of oil to $20 a barrel. All that did was spark innovation to lower the cost of getting oil out of the ground. As a result, any increase in price of oil has a direct and positive impact on the bottom line.
- Higher worldwide demand.
Some might be surprised by our mention of higher demand for oil. It is a frequently cited point that energy demand from fossil fuels is (and will continue) falling due to an increased use of alternative energy sources like solar. The chart below from JP Morgan shows that not only are we seeing an increase in oil production, but consumption as well. If you listen to CNBC, all they talk about is the supply of oil growing because of fracking and they make it sound like we are awash in oil. They never talk about demand. Oil prices dropped in 2015 because we were producing 1.4 million barrels of oil per day more than was needed. This was the result of Saudi Arabia trying to drive US producers out of business. By 2017, the story had completely turned around as the world was consuming about 400,000 barrels a day more than what was being produced. In 2018, JP Morgan expects supply and demand to be in line with one another. More importantly, the world is consuming MORE energy! In 2014, the world needed 93.6 million barrels of oil a day while today the need sits at 100 million barrels per day. This is an exciting story – a growing sector that is selling significantly below historic valuation measures. Hard to find that anywhere else in the markets today.