Filling Up on Energy Funds
At the Morningstar conference, two veteran fund managers discuss the oil market.
Say hello again to $70-a-barrel oil. Every time crude prices slip, it seems they bounce back in a market as tight as a drum. If it's not a surge in demand from the thirsty motorists of China, then it's supply problems from unstable Nigeria or geopolitical tension engendered by the latest threats from the demagogues running Iran or Venezuela.
Here's some advice: Instead of getting mad at the gas pump, an act of futility, consider filling up on energy funds. To hear John Dowd of Fidelity or Dan Rice of BlackRock present in the "hard assets" session of late June's Morningstar conference, in Chicago, is to believe that high oil prices are here to stay.
The message from these two veteran natural-resources portfolio managers is similar. Dowd thinks the world price is driven by the cost of bringing on profitable new supply in the U.S., which he calculates to be $70 a barrel now (remember that OPEC is a cartel, not a predatory competitor bent on undercutting higher-cost producers). The industry is also afflicted with high inflation, driven by everything from the cost of rigs to the cost of labor.
Rice says that global supply is in part constrained because national oil companies, which are in the saddle these days, are severely underinvesting in exploration and production. As a rule of thumb, he says, a private oil company used to reinvest 65% of 70% of operating cash flow. Authoritarian leaders like Chavez of Venezuela, he figures, instead spend 90% of cash flow on social programs to stay in power and reinvest only 10% in oil. Exxon's reinvestment rate, he notes, has collapsed from 75% to less than 40% because of lack of opportunity.
Rice calculates that the market is pricing in $50-to-$51-a-barrel crude in the current values of oil-company stocks. This, he says, implies appreciation potential of 40%, especially since stocks today should be discounting future prices of oil, which are on the rise. Dowd likes oil refiners such as Valero Energy (symbol VLO) and services firms, including Schlumberger (SLB). Rice, who has a broader investment mandate, is keen on coal and natural gas as well as the oil patch.
You can tap Dowd's oil expertise through his fine Fidelity Select Energy (FSESX). Over the past five years through July 2, it returned 26% annualized. Rice has his hands in several funds. BlackRock Global Resources (SSGRX), a superb performer that he co-manages with Denis Walsh, is a load fund and it's closed to new investors. The pair also run All-Cap Global Resources (BACAX), which launched in February 2005 and returned 20% over the past year. The fund's class A shares levy a front-end sales charge of 5.25%.
Rice and Walsh run a closed-end fund, Global Energy & Resources Trust (BGR), although this is quite a different, income-oriented animal. Over the past year, the fund returned 23% on assets and closed on July 2 at an 11% discount to its net asset value per share. (Closed-ends usually trade at a discount or premium to their assets; return on assets is a reflection of the manager's skill; return on share price also reflects investor sentiment.)