LDN - Business

Some U.S. fund managers finally convinced oil rally is for real

[May 11, 2018] By David Randall

NEW YORK (Reuters) - U.S. fund managers are barreling into the energy sector by making broad bets on anything connected with oil, finally convinced that gains in crude prices - on track for their fourth consecutive quarterly gain, the longest such stretch for more than 10 years - are more than a mirage.

Ever since oil prices slid in late 2014 after rallying above $115 a barrel, U.S. mutual fund managers have largely stayed underweight the sector, convinced that advances in fracking technology would allow U.S. production to ramp up at any moment and keep a lid on prices.

Yet with oil futures hitting 3-1/2-year highs on Thursday, up approximately 75 percent from this time last year after top exporter Saudi Arabia and No.1 producer Russia led efforts since 2017 to cap output, some U.S. fund managers are convinced that high oil prices are finally here to stay.

Fund managers from Westwood, Hotchkiss and Wiley, and Hodges Capital are among those who say they are making broad bets on anything oil.

They say that oil prices will not dip back down quickly because global demand is rising at a time when energy companies are showing less inclination to take on debt to fuel production and have tightened operations.

"Oil companies are so much more efficient then they were even a year ago and much more disciplined. I think that you can finally say that this is the real deal," said Gary Bradshaw, a portfolio manager at Dallas-based Hodges Capital.

At the same time, U.S. President Donald Trump's decision to withdraw from the Iran nuclear deal on Tuesday raises geopolitical risks, giving oil another leg higher, fund managers said.

U.S. crude hit $71.89 per barrel on Thursday, its highest since November 2014. A Reuters poll at the end of April forecast that oil would average $63.23 in 2018.

Bradshaw expects crude oil prices to stay at roughly between $65 and $70 for the remainder of the year, boosting the earnings of companies such as Schlumberger NV and Diamondback Energy Inc.

Still, Bradshaw does not see them spiking high enough to significantly cut into consumer spending or the broader economy, although they may crimp the spending power for the most price-sensitive customers, he said, which could eat into the revenues of value chains like Dollar General Corp.

OIL COMEBACK

The dramatic comeback in oil prices, which have jumped nearly 17 percent for the year to date, has helped the S&P 500 Energy sector jump 5.4 percent over the same time. The broad S&P 500 as a whole, by comparison, is up less than 1 percent since the start of the year.

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Oil pours out of a spout from Edwin Drake's original 1859 well that launched the modern petroleum industry at the Drake Well Museum and Park in Titusville, Pennsylvania U.S., October 5, 2017. REUTERS/Brendan McDermid/File Photo

That, in turn, is prodding fund managers back into the sector they had largely shunned.

Nine months ago, global funds were underweight energy stocks by 12 percent on average, the largest collective underweight since 2016, according to a September report by Bank of America Merrill Lynch.

In April, by comparison, equity allocations to commodities and energy stocks hit eight-year highs, Bank of America Merrill Lynch noted.

"We've already had some of the catch-up trade, but we still have a long way to go," said Bill Costello, a senior portfolio manager at Dallas-based Westwood, who has been adding to his positions in energy companies such as Callon Petroleum Co and SRC Energy Inc

While energy stocks have rallied, shares are still trading at levels that suggest that oil will remain between $55 and $58 a barrel for the remainder of the year, Costello said.

"If people believed in $70 a barrel plus for the next 18 months, they would be foolish to be underweight now," Costello said, adding that he expects more money to flow into the sector as fund managers sell utilities and telecom stocks that are getting hurt by rising interest rates.

The stretched valuations of the S&P 500, which is about 7 percent below the record high it hit in January, should provide another support for energy stocks, said Stan Majcher of the Hotchkis & Wiley Mid Cap Value Fund.

"We look at it and say the overall market is close to expensive and this is one area which is under-owned and viewed in the last few years as a risky place," he said.

Signs of declining production by OPEC countries such as Venezuela and bottlenecks that could slow production in the Permian Basin in the U.S. could push oil prices well above $70 by the end of the year, leaving fund managers flatfooted, Majcher said.

"We think that the biggest risk is not preparing for higher oil prices," he said.

(Reporting by David Randall; Editing by Marguerita Choy)

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