Sometimes, I like to play the contrarian. A friend once told me nobody builds a statue to a crowd, and being a hero with your investments sometimes requires zigging when everyone is zagging. The energy sector has been lagging the S&P 500. Its relative underperformance may present an opportunity for outperformance if you think sector returns mean revert over time.
What is relative performance?
Relative performance measures the returns of a stock or sector against another stock, sector, or market index. Relative performance is usually measured either by comparing returns over time or on a spread basis using a ratio of the assets being compared. Institutional investors and hedge funds tend to focus more closely on relative performance than retail investors.
Global energy demand has been slow and refiners pressured:
Energy shares have been pressured by slower global growth, especially the weaker tone of growth in the emerging world in places like China, India, and Brazil. The International Energy Agency (:IEA) has global oil demand growing 1.1% this year to 90.8 mbd and 1.3% next year to 92.0 mbd. Political and social unrest in Egypt and Syria has not been a clear benefit to energy equities on a relative basis.
U.S. based refiners have been hurt by a narrowing of the WTI/Brent oil spread (higher input costs relative to output costs) and the increased cost of blending credits for renewable fuels. These factors are out in the open.
However, there are a few bright spots for the energy market:
All is not negative for the energy sector. Crude oil prices have been rising in recent weeks and are generally improving the outlook for company profits outside of the refining sector. West Texas Intermediary has risen over $15/barrel since late June, while Brent prices are up around $8/barrel. Although some of the gain is being blamed on an unwinding of the Brent/WTI spread, there are fundamental drivers at work.
First, China’s apparent oil demand rose 4.8% m/m and 11.7% y/y in June to 9.99 mbd. Chinese demand for oil may be starting to improve.
Second, the glut of West Texas Intermediary crude oil in storage seems to be loosening with the recent draw in inventory. In recent weeks, WTI inventories have fallen 27.1 mln barrels from their high. A decline this time of the year is normal, but the drop has been strong to the 5 year average. Seasonally WTI inventories should be pressured into the late summer or early fall.
Third, U.S. refinery run rates have been hot. Refinery utilization was 92.8% at last measure and well above the 88.0% recorded at the same time last year. Demand looks healthy.
Fourth, hot weather has helped to reduce natural gas inventories which stood about 1% below the five year average in the week ending July 12th.
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