Energy by its very nature is volatile. Yet, the energy sector of the equity markets has proven to be a relatively safe haven for investors; often out-performing the general market. That is due in part to the omnipresence of energy. Everything in our modern society is powered by energy – even the digital world we live in has its foundation in energy. Energy and access to energy resources are an economic priority for future generations, just as they have been for past generations.
So how do we tap into the sector? With cautious optimism and a practical perspective.
At Petroleum & Resources Corporation, we believe fossil fuels will continue to be the primary source of energy for at least the next 20 to 30 years. Our rationale is simple: As long as the cost of a barrel of crude oil remains “reasonable” and the infrastructure to distribute energy does not dramatically change, the world’s consumers will continue to rely on petroleum and coal to produce most of their energy needs. Yes, we believe that alternate sources of energy – such as nuclear, hydro, solar, wind and bio fuels– will be called on to meet more and more of our energy needs; however it seems unlikely that these alternatives can replace fossil fuels as the pre-eminent source of energy any time soon. Until the cost of generating energy through alternate sources becomes more economical than fossil fuels, oil will remain “king.”
In order to take advantage of the opportunities in the sector, we invest the large majority of our fund in five sub-sectors– Integrated Oil Companies; Exploration and Production; Utilities; Services; and Basic Materials. The integrated oil companies, such as Exxon/Mobil and Chevron, are an important part of the portfolio because they are the dominant players in the energy sector. It is no surprise that the major integrated oil companies are some of the largest capitalized companies in the world, rivaling the economies of some small nations. The amount of resources required by these companies to find the reserves, to refine the crude, and eventually transport and distribute it to consumers is enormous. Their reach is truly global. Their actions are intertwined with many of the major international financial and political challenges of the day. And yet, these organizations have mostly remained stable. They have generally been able to assemble solid management teams with deep bench strength. They have managed their assets to weather challenges as well as to invest in future initiatives. Year after year, they have shown the ability to make money. These are among the reasons why we have maintained varying equity positions in many of these companies for decades.
Companies that generate revenue from exploration and production will remain important within the energy sector as long as the world’s voracious appetite for energy endures. As the demand for energy continues to increase, more reserves will need to be found, more wells will need to be tapped, and refineries will need to ramp up production. Within the past 5 years, several companies in the sector have merged and consolidated. These types of merger and acquisition activities have led to somewhat of a windfall for our shareholders and for us. All of these factors provide intriguing investment opportunities in the sector.
The providers of services to the integrated oil companies and the exploration and production companies are an important part of the industry as well. Most companies hire specialists in areas such as well-logging, seismic studies, drilling operations and rigs, pressure-pumping, and others. Since this sub-sector of the industry tends to have a different business cycle than its customers, it serves as an excellent counterbalance to the cyclical performance of the oil companies and their equities.
Gas utilities also have a different business model than the producers of oil and gas. Providing natural gas to residential and business customers, they are similar to electric utilities, subject to regulation by local Public Utility Commissions and others. They are an excellent source of dividend income for us, with steady incomes and cash flows.
While some consider basic materials as a totally separate sector from energy, it is quite similar in many ways and thus has a place in the portfolio. Oil, gas, coal, copper, gold, and iron are some of the primary basic materials for industry and must be analyzed in similar ways, so we are able to leverage the capabilities of our analysts through investing in the wider field.
While we believe the world’s dependence on fossil fuels will continue, we are actively evaluating opportunities in the emerging area of alternative energy forms. We are watching this area closely as all the major integrated oil companies and governments look to find ways to tap into nuclear, wind, solar and hydro energy sources. And we are well aware that more intellectual, entrepreneurial, financial, and political capital is being spent in these categories than ever before. While the technology is promising, creating distribution channels and generating a profit from these power sources is likely to take far longer than most people realize. But when attractive investments in alternative fuels arise, we will be there ready to analyze their longer-term prospects and to take advantage of them.