Energy sector continues to suffer as oil price declines

Tactical managers face a dilemma as increased U.S. production drives sell-off

Nov 4, 2014 @ 12:24 pm

By Trevor Hunnicutt

The price of oil is falling, adding new pressure to energy stocks already posting lackluster returns this year.

Saudi Arabian Oil Co. lowered the cost of the crude it ships to the U.S., where production is the highest in three decades, deepening a sell-off that sent prices to the lowest in more two years.

The news came as a fresh blow to investments in energy companies in the U.S.

The largest energy-tracking ETF, the Energy Select Sector SPDR (XLE), is down 2.42% for the month ended Nov. 3. It's down nearly 1.36% year to date.

The S&P 500 has returned nearly 11% for the year.

The sector's poor performance is a challenge for tactical investors, including Wells Fargo Advisors' home office strategists, who have maintained even exposure to energy stocks, according to Scott Wren, a senior equity strategist for the wirehouse.

“In hindsight, of course, you would've liked to have been underweight because obviously the only sector down for the year is energy — and it's down quite a bit — so there's been massive underperformance there,” said Mr. Wren. “I'm pinning it on the slower global growth and that being more of a problem.”

Benchmark U.S. crude oil fell to $76.56 a barrel in Tuesday trading. The S&P 500 was down about half a percent to 2,008.06, led by energy stock declines totaling 1.74%.

Portfolio manager Patrick O'Shaughnessy said an unduly negative narrative has coalesced around energy companies.

While once investors thought the U.S. was doomed to be dependent on pricey foreign oil supplies, now people increasingly believe the U.S. is destined to produce an increasing amount of energy from fast growing sources like North Dakota's Bakken formation, decreasing prices and its dependence on foreign oil.

“It's been awhile since we've had a broadly negative narrative on a sector like this,” said Mr. O'Shaughnessy, a portfolio manager at O'Shaughnessy Asset Management who blogs at Millennial Invest. “We think there's opportunity when there's a gap between reality and perception.”

Mr. O'Shaughnessy, who has studied energy stock price action through history, said downward oil price moves generally cause broad stock price declines. But those declines are then followed an enduring run-up in prices, averaging 18.94% for all large energy stocks over a one-year time frame, he said.

Taking advantage of this “gap between reality and perception,” he has been buying energy company shares.

Three decades ago, Saudi Arabia cut production by almost two-thirds in an attempt to stem a drop in global oil prices. The strategy backfired as new supply from areas like the North Sea flooded the market, pushing prices down by about half to $10 a barrel in 1986, ushering in an era of budget deficits in the country most endowed with oil wealth. It took the 1990 Iraqi invasion of Kuwait to propel Saudi production past 8 million barrels a day again.

The country is now seeking to maintain sales above that level to sustain its position in the market, Fereidun Fesharaki, chairman of Singapore-based consultant FACTS Global Energy, said Monday. OPEC is scheduled to meet Nov. 27 in Vienna to discuss production levels.

The world's largest exporter is pumping oil at close to the fastest pace in more than two decades. Production at about 9.7 million barrels a day on average this year is down from the 10 million barrel-a-day peak in September 2013, according to production estimates compiled by Bloomberg News.

This story was supplemented with reporting from Bloomberg News.

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