Historically, the Invesco International and Global Growth team has taken an underweight position in the energy sector because we believe that over the course of an economic cycle, few oil-and-gas producers can consistently earn above their cost of capital. Additionally, we see many management teams prioritize volume growth over returns – a strategy that eventually pushes prices down to or below the median break-even cost curve. But after the recent carnage in the oil markets, we’re beginning to dust off some of our energy-company files in search of opportunities.
A focus on quality will be critical to finding companies that can survive – and thrive – in this space. The majority of energy companies are not able to tap the markets for new debt, and that means more dividend cuts, high-cost equity dilution or highquality asset disposals are their only options. We expect to see several bankruptcies in 2016.
Our view on oil
We think that oil prices of US$31 a barrel are not economically feasible for the industry, and at least 1.5 million barrels a day of supply will need to come out of the market to help bring supply and demand back into balance. Indeed, we are likely to see accelerated volume destruction in the second half of 2016 as companies have been cutting their capital expenditures down to maintenance levels: The North American rig count is down 57% year over year and more than 63% from its 2014 peak† . In the meantime, however, the Saudis seem prepared to suffer big deficits in order to drive competition out of the market.
While lower-quality companies tend to outperform during short-term commodityprice rebounds, we believe the higher-quality large caps remain the better long-term plays as we are unlikely to see oil at US$80 per barrel anytime soon. In addition to much faster global growth, a period of U.S.-dollar weakness would be necessary for commodity prices to show any positive long-term trends. With U.S. government bond yields paying more than other developed markets, we would need to see that gap begin to close for the U.S. dollar to depreciate.
Our energy holdings
Our largest oil holding is Suncor Energy Inc. (0.90% of Invesco Global Growth Class, 1.75% of Invesco Canadian Premier Growth Fund and 1.23% of Invesco Canadian Balanced Fund as at December 31, 2015), a Canadian oil sands integrated company that has one of the strongest balance sheets in the sector, as well some of the lowest-cost oil sand assets with a long-life production profile. Suncor is taking advantage of the downturn by agreeing to acquire Canadian Oil Sands Ltd. for shares (not a holding of the above-mentioned funds as at December 31, 2015). This deal would raise Suncor’s stake in the Syncrude oil sands project, which is the largest oil sands project in the world and has 40 years of proved and probable reserves.
Another of our energy holdings, Royal Dutch Shell PLC, is buying BG Group PLC at a time when few companies have the balance sheets to even contemplate such a deal. (Royal Dutch Shell is 1.01% of Invesco European Growth Class and 0.78% of Invesco Global Growth Class as at December 31, 2015. BG Group is not a fund holding.)
We believe companies like Suncor and Royal Dutch Shell typically come out of these downdrafts much stronger and should be able to drive higher future returns at a lower oil price.