energy sector analysis brian r. boulter fisher college of business 2/13/07
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Energy Sector AnalysisEnergy Sector Analysis
Brian R. BoulterBrian R. Boulter
Fisher College of BusinessFisher College of Business
2/13/072/13/07
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S&P 500 Sector AllocationS&P 500 Sector Allocation
10.76%
9.29%
9.69%
22.18%
12.21%
10.82%
15.07%
3.05%
3.57%
3.35%
7.82%
6.69%
7.73%
20.71%
17.53%
11.34%
16.38%
1.53%
7.44%
1.21%
0.00% 5.00% 10.00% 15.00% 20.00% 25.00%
Consumer Discretionary
Consumer Staples
Energy
Financials
Health Care
Industrials
Information Technology
Materials
Telecommunication Services
UtilitiesSIM Weight
S&P 500 Weight
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SIM Relative to S&P 500SIM Relative to S&P 500
-2.93%
-2.60%
-1.96%
-1.47%
5.32%
0.52%
1.31%
-1.52%
3.87%
-2.15%
-4.00% -3.00% -2.00% -1.00% 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%
Consumer Discretionary
Consumer Staples
Energy
Financials
Health Care
Industrials
Information Technology
Materials
Telecommunication Services
Utilities
% Overweight / (Underweight)
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Energy Sector CompositionEnergy Sector Composition
• Coal & Consumable Fuels - 1.38%• Peabody Energy, Consol Energy Inc.
• Integrated Oil & Gas - 63.76%• Exxon Mobile, Chevron, ConocoPhillips, Marathon Oil, etc.
• Oil & Gas Drilling – 4.21%• Transocean Inc., Noble Corp., ENSCO Int’l, etc.
• Oil & Gas Equipment & Services – 13.39%• Baker Hughes, Schlumberger Ltd., Halliburton, Smith Int’l, etc.
• Oil & Gas Exploration & Production – 9.61%• Anadarko Petroleum, Apache Corp., Devon Energy Corp., etc.
• Oil & Gas Refining & Marketing – 3.30%• Sonoco Inc., Valero Energy
• Oil & Gas Storage & Transportation – 4.34%• Kinder Morgan, El Paso Corp., Spectra Energy Corp., etc.
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Recent PerformanceRecent Performance
# of Companies MTD QTD YTD
Materials 29 0.63% 5.13% 5.13%Utilities 32 3.78% 3.39% 3.39%Health Care 56 -0.23% 2.77% 2.77%Consumer Discretionary 89 -0.02% 2.74% 2.74%Telecommunications Services
9 -1.43% 1.62% 1.62%
Industrials 52 0.11% 1.42% 1.42%Consumer Staples 38 -0.65% 1.18% 1.18%Financials 87 0.11% 0.81% 0.81%Information Technology 75 -0.84% 0.71% 0.71%
Energy33 0.78% -1.09% -1.09%
S&P 500 500 -0.01% 1.39% 1.39% Total Return 0.07% 1.58% 1.58% Net Total Return 0.05% 1.53% 1.53%
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Oil & The Energy SectorOil & The Energy Sector
• Energy Sector revenues are driven by global oil prices– Impact current and future levels of
exploration, drilling and refining expenditures
• S&P 500 sector index is heavily weighted with Integrated Oil & Gas companies– Earnings almost perfectly correlated with
crude oil spot prices
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Oil & The Energy SectorOil & The Energy Sector
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*R^2 = 0.93
**93% of the change in the Energy Sector’s quarterly earnings is explained by the corresponding increase/decrease in the spot price for crude oil
***Based on 10-Q’s and average quarterly spot prices 1993-2007
Representative Energy Sector Quarterly Earnings Regressed against WTI Crude Oil Spot Prices
(14 Years)
0
50,000,000
100,000,000
150,000,000
200,000,000
250,000,000
- 10.00 20.00 30.00 40.00 50.00 60.00 70.00 80.00
Crude Oil Spot Prices
$ Millions
Y
Predicted Y
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World Oil Market OverviewWorld Oil Market Overview
• Long-Term oil prices are relatively stable– Driven by global supply and demand
• Abundance of proven oil reserves makes extraction cheaper and prices lower
• Short-Term prices are more volatile– Impacted by political, economic and environmental
shifts• War, recession, weather, etc.
• The long cycle of the petroleum industry has been a recurrent pattern for more than 140 years
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Commodity Cycles Are Long-Commodity Cycles Are Long-Term Business CyclesTerm Business Cycles
Source: Hess Energy Trading Company, LLC
(Soft Landing)
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Energy Cycles 1876-2005Energy Cycles 1876-2005
Source: Hess Energy Trading Company, LLC
Historically, energy cycles last +/- 20-30 years from peak to peak.
Last peak was reached in 1981… 2006 marks 25 years exactly!
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Global Oil ConsumptionGlobal Oil Consumption
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Global Oil SupplyGlobal Oil Supply
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Middle Eastern Oil SupplyMiddle Eastern Oil Supply
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Global Oil ReservesGlobal Oil Reserves
Among the top 20 oil reserve holders, 8 are OPEC member countries that together account for 65 percent of the worlds total reserves.
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What’s Happening to Oil?What’s Happening to Oil?
• Natural petroleum resources are not projected to be a key constraint on world demand through 2030
• Forecasted oil price paths reflect alternate assessments of oil-rich countries’ willingness to expand production capacity as much as previously indicated– Also reflects expected costs of extraction
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$34
$57
$96
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The High’s and Low’sThe High’s and Low’s
• The high price case assumes that the worldwide crude oil resource is 15 percent smaller and is more costly to produce than assumed in the reference case.
• The low price case assumes that the worldwide resource is 15 percent more plentiful and is cheaper to produce than assumed in the reference case.
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The Bottom LineThe Bottom Line• Long-term supply vs. demand will be most heavily
impacted by the politically and economically motivated production decisions of oil-rich countries– OPEC Nations, Middle-East, etc.
• OPEC has declared that current oil prices are acceptable at $50-$60– No significant production cuts are scheduled in the short-
run
• Global reserves have increased significantly since 2002– May be used strategically to mitigate severe
supply/demand imbalances and stabilize prices
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Absolute ValuationsAbsolute Valuations
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Relative ValuationsRelative Valuations
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Energy Sector ValuationEnergy Sector Valuation
• Absolute Sector Valuation– Trading below 10 year average: Cheap
• Relative Sector Valuation– Selling at a discount to the market
• Some measures indicate that energy is cheap• Overall: in-line historically relative to the market
• Sector earnings/stock prices driven by oil:– Oil likely to hover between $45 & $60 per barrel in the
short-term– Energy stocks Likely to decline further for 6-8 months
and begin to trade sideways once oil prices level off
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Sector RecommendationSector Recommendation
• Energy sector stock prices are still adjusting to reflect the recent decline in future forecasts for oil prices– 5-6 month delay
• Recommend to decrease current SIM portfolio weighting to 7.00%– Sell 73 basis points to reach 269 basis points below
S&P 500 weighting
• Look to move towards equal weighting after 12-14 months