Where’s the oil price heading? Is it time to buy oil stocks? Jonathan Waghorn, co-manager of Guinness Global Energy Fund, answers our questions and discusses ideas generation and alternative energy.
Oil is currently at multi-year highs. Where do you see the price heading from here and what are the key drivers? Is $100 oil possible?
It’s the billion-dollar question. $100 oil is possible, $40 oil is possible, we live in a volatile commodity world. We work on an outlook of $60, moving, probably, to $70 crude oil and we’re happy with those as estimates.
Typically, we’d see 30% volatility in any one year, so we could easily get back up towards $100 oil. Saudi was recently talking about $80 to $100 as being a reasonable price. We’d be somewhat more cautious, anything over $80 would start to cause demand destruction and that is a bad thing, overall, for our sector, but a key point is, small changes in supply and demand can bring about very, very quick changes in price.
Bear in mind, it was only ten years ago that we were at $150 crude oil, we could easily get back there again, should this market tighten over the coming years.
Is it time to buy energy stocks?
So, the outlook for energy equities, actually, is looking pretty interesting. I’ve mentioned oil prices and sensitivity, but the key thing for energy equities is that profitability is very much under pressure at the moment, and there is an increasing likelihood that profitability improves and that free cash generation also improves. If that happens and the market pays for it, then we believe there is good upside to be seen.
So, to put numbers behind that, our portfolio had a trough return on capital employed in 2016 at 1%, it’s currently at about 5% and the long-run average has been somewhere in the order of 10%, 11% or 12%. Should we return to that level of profitability and the market price that in is being sustainable, then we would expect to see 40% to 50% upside in energy equities.
That could well happen on a three to five-year view, so yes, there is absolutely an opportunity, it is always going to be volatile, but on a three to five-year view, we’re very comfortable that an absolute and relative return in energy should be good.
How effective are oil and energy stocks as a hedge against inflation? What central banks interest rate rises mean for oil prices?
So, historically, the commodity space, the resources space, has been very good as a hedge against inflation, predominantly because it’s been, typically, the cause of the inflation. So, it’s been good to own the inflationary component. Looking forward, we see no reason why that shouldn’t be the same in the future.
We’ve also, historically, found that energy equities provide better returns than energy commodities themselves, so, therefore, you’re better placed to own the equities as opposed to the commodities in those inflationary environments. So, looking back in the S&P since the 1920s, there have been eight periods of inflation and we’ve found that resource equities outperformed in six out of those eight situations over the last, sort of, 100 years or so. So yes, energy equities should be a good hedge against inflation for the future.
Where do you get your ideas from? Our ideas are generated on a weekly basis on a screen that we run, so it’s a very quantitative process, a very disciplined process, and we save those screens and have them over the last 20 years or so.
We would much rather do that than go to a conference, meet a good CEO who talks a good story and then end up buying his equity. Better to do a disciplined approach, looking for quality stocks displaying value characteristics where, potentially, earnings movements and share price movements are on the up. That’s the kind of name that we’re looking for in a disciplined screening process.
Do you see alternative energy becoming more important going forward? Has your exposure increased since the fund launched?
Alternative energy is absolutely becoming more important, certainly from the macro point of view. The question and the issue we have is, trying to find good companies to own that provide us, as equity holders, a good return on that investment, and that’s been difficult to do over the last few years.
So, the macro has grown, solar has grown, wind has grown, but there have been few names that have delivered positive returns. Over the last five years, we’ve had between 0% and 6% weight to alternative energy within the portfolio, we’re currently at about 2%.
Our views on oil price mean that we see good opportunity there, so expect us to continue to play that. Longer-term, expect to see more alternative energy and renewable energy within the portfolio.
Why did you become a fund manager? What do you like to do with your time away from work?
My career has been in energy all of the way through, so I started my career as a drilling engineer, working for Shell, in the North Sea. I then worked through management consultancy, sell-side research and then moved into fund management.
I’m very, very lucky to have this as a job, I can sit here and look at the industry and pick stocks, and I have a phenomenally advantaged position to do that. So, I love doing it and will continue doing it.
From the point of view of spare time and free time, I have two boys who are 9 years old and 12 years old, so I don’t have very much free time at all. Keeping them busy and taking them everywhere, generally, is what takes up most of my weekends.
Nonetheless, this weekend, I’m off to the Peak District with my brother to go walking for the weekend, so that’s pretty good, I try to get a bit of time for myself.
This is the transcript of a video filmed on 26 April 2018. To watch the original video, please click here.
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