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
* 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
Canadian equity market performance.
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
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