MARKET REVIEW
So far into the results season, the energy sector has had a “beat ratio” lower than the market average, as 54% of the reporting companies have beaten expectations versus 62% for the market. Within the Fund, this “beat ratio” has been high (63%).
On the economic front, US data has been strong, raising worries over an earlier-than-expected increase in interest rate. The demise of Portugal’s largest bank and the “partial” default of Argentina have also shaken confidence. In China, however, PMI came in strong showing a persistent recovery. Most recent data is also showing a solid pick-up in non-OECD oil demand (over 50% of global oil demand).
THEMATIC INSIGHT
Despite increased geopolitical tensions, near-term crude oil prices have been more impacted by the return of some Libyan barrels to the market and by a fire at a refinery in the US. However,long-term worries are still in place and have likely increased due to sanctions on Russia and instability in Iraq. The International Energy Agency had expected Iraq to be the largest contributor to growth in world oil supply in the near term (World Energy Outlook 2012, IEA). As an illustration of increased long-term concerns, oil price forward curves have not corrected.
During the month we met with 16 companies in Calgary, Canada. Those meetings confirmed our constructive stance on the Montney and Duvernay geological plays which are expected to be key to Canadian shale oil and gas growth. Activity levels are expected to remain elevated thanks to the combination of a higher Canadian gas price due to current low gas inventory levels, a lower Canadian dollar exchange rate versus the US dollar and a ramp-up of drilling for LNG export (in particular from Petronas). However, valuations of Canadian E&P seem rich currently versus their US peers. We, therefore, prefer to maintain our exposure to Canada mainly through service companies either in pressure pumping, onshore drilling or worker camps.
QUARTERLY OUTLOOK
We maintain our strong focus on those companies that will benefit from repeatability, growth and capital efficiency provided by the North American tight oil and shale gas revolution.
As of the end of the month, over 75% of the Fund continues to be invested across the North American shale value chain, where we keep seeing the best overall combination of risks and rewards.
About 40% of the Fund is exposed to North American E&P, with strong exposure to the Bakken, Permian, Eagle Ford and Utica basins. About 20% of the Fund is exposed to increased service intensity in the North American onshore market, that is characterised by the compound effects of higher horizontal rig count, more wells per rig and more frac stages per well. Furthermore, increased quantity of sand used in the hydraulic fracturing of shale formation is particularly benefiting sand producers to which the Fund is invested. The Fund is exposed to related industries that are beneficiaries of this “shale revolution” with 8% to refiners/chemical producers, 6% to companies providing logistics and transportations, and 3% to other industries.
Sincerely,
LOF Global Energy team