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Energy investors no longer over a barrel?
11/21/2017 10:41:55 AM
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By Fund Library News Wire  | Thursday, August 31, 2017


 



By Kurt Reiman, Director, Chief Investment Strategist for Canada

The rollercoaster ride in oil prices over the past three years may be old hat to investors familiar with the commodity’s historical sensitivity to macro events (see chart below), but oil price volatility is by no means endemic, and several factors are now lining up to suggest a calmer period for crude may lie ahead.

For starters, global oil production appears more closely in line with demand following a prolonged search for a new equilibrium amid a breakdown in the Organization of Petroleum Exporting Countries (OPEC) cartel and increasingly productive oil extraction technologies in North America. In our view, a sustained global economic expansion should support consumption, while underinvestment in the energy sector likely limits the rise in future production even though technological advancements have lowered the breakeven cost of that production.

Many analysts also expect oil prices to stay in a narrower range over the next year, according to a June 2017 survey data from Bloomberg. Comparing the most recent distribution of estimates with previous points in history (see chart below), there is greater clustering around the mean and noticeably shorter tails, suggesting a lower likelihood of major price swings over the next year.

Given the strong correlation between oil prices and energy company earnings, it is not surprising that earnings estimates for the energy sector are moving closer together as well. The recent uptick in earnings revisions for the energy sector (see chart below) currently appears strong, but it is important to interpret this move with a grain of salt. The chart below also shows there is no apparent trend in energy earnings growth, which contrasts with other sectors in the Canadian equity market such as financials, consumer staples, telecoms, and utilities, which have exhibited an upward sloping trend over time.

The reemergence of a prevailing consensus might be positive if it means more predictable earnings growth and more stable dividends for an otherwise schizophrenic sector. Assuming oil prices stay in this narrow range, we believe there are some important implications of lower oil price volatility for investors:

* Energy could command higher valuation multiples, as investors would likely be more willing to pay a premium compared to history for earnings, dividend and share price stability.

* An above-average dividend yield (the MSCI Canada Energy Index is yielding an annualized dividend of 3.6% versus 2.9% on the overall MSCI Canada index, according to Bloomberg data as of July 31, 2017), and lower price volatility could make energy a more attractive sector for income-seeking investors in a low yield world.

* Banks, which lend heavily to the energy sector and represent a rather large share of the Canadian market, would see less earnings volatility if oil prices were to stabilize.

* With energy and financials accounting for nearly two-thirds of the MSCI Canada index, a combined strengthening of the two sectors could positively influence overall Canadian equity market performance.

Kurt Reiman, Director, is BlackRock’s Chief Investment Strategist for Canada and is a member of the BlackRock Investment Institute (BII). Daniel Donato, analyst with BlackRock in Canada, contributed to this article.

Notes and Disclaimer

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared in the BlackRock Blog on the BlackRock Canada website.

Important information

Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Past performance is not a guarantee of future results. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

© 2017 BlackRock Asset Management Canada Limited. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. Used with permission. 248346

 
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