Some U.S. fund managers risk long-term bets on tanking oil sector

FILE PHOTO: Natural gas flares are seen at an oil pump site outside of Williston
FILE PHOTO: Natural gas flares are seen at an oil pump site outside of Williston, North Dakota March 11, 2013. REUTERS/Shannon Stapleton/File Photo

April 21, 2020

By David Randall

NEW YORK (Reuters) – Some U.S. fund managers are attempting what seems like an impossible task: making bets on the stocks and bonds of energy companies at a time when oil futures have sunk to historic lows and a swelling global glut shows no sign of letting up.

On Monday, traders holding the expiring front-month May contract for U.S. crude had to pay nearly $40 per barrel to unload oil as they scrambled to avoid having to take delivery.

With supply looking like it will far exceed demand for weeks, oil contracts for June on Tuesday were at two-decade lows, with global benchmark Brent down 24%, to settle at $19.33 a barrel and U.S. crude for June down 43% to $11.57. [O/R]

The United States Oil Fund ETF was down more than 20% on Monday.

Energy stocks in the S&P 500 are down nearly 45% for the year to date, more than triple the 15% decline in the broad index over the same time. Yet some fund managers with longer time horizons say that they are investing in assets ranging from shares of storage facilities to distressed debt that they say could offer outsized returns over the next five years.

“The market has been reacting violently because we’ve never seen anything like this before,” said Charles Lemonides, portfolio manager of hedge fund ValueWorks LLC. “Right now we’re pumping 50% more oil than we’ve been using and it isn’t’ going to end anytime soon.”

Lemonides is focusing on moving into senior debt issued by companies with what he calls “clean capital structures” that have valuable assets but may go through a bankruptcy or capital reorganization. He is buying debt issued by Oasis Petroleum Inc that trade at 10 cents on the dollar. Shares of the company trade at 25 cents, down from $14 per share in Oct 2018.

He’s largely staying away from equities unless they have “special circumstances” that could allow then to offer upsides over the next two years that are 3 to 10 times their current prices, he said. Offshore services company Tidewater Inc, for instance, “we are confident in because they recently went through bankruptcy and have no debt,” he said.

Eric Marshall, a portfolio manager at Hodges Capital, was overweight energy stocks before the global economic lockdown and has been stung. Yet he believes “there are still ways to play this” even though “no one knows how long it will take for demand to come back,” he said.

He has been buying shares of Scorpio Tankers Inc, which has seen a surge in demand as traders hunt for storage capacity. Shares are up 65% over the last month but remain down 40.5% year to date. He is also seeking companies with low debt and strong cash flows such as Texas Pacific Land Trust, which reaps royalties from its portfolio of oil fields.

“You know this company will come back, it’s just a matter of timing,” Marshall said.

Some investors remain bearish that oil and energy stocks will ever come back. Low-cost U.S. shale production along with improvements in energy efficiency and alternative sources of energy have made traditional oil companies unattractive since at least 2014, said Margie Patel, a senior portfolio manager at Wells Fargo.

“The supply demand imbalance is going to trap oil and gas into much lower trading range” than its typical range of $40 to $60, she said.

Still, there could be room in energy for income investors who generally eschew speculative bets, said Linda Duessel, senior equity strategist at Federated Hermes.

She remains bullish on major oil companies such as Exxon Mobil Corp that will emphasize payout ratios even if oil prices remain low, she said.

“A lot of companies who pay dividends and can no longer afford them are more likely to suspend or defer than those who have the culture to say ‘This is one of the most important things to our shareholder base,'” she said.

While she still considers energy “the worst sector” of the S&P 500 to invest in overall, there are enticing opportunities in companies with strong balance sheets for investors who have a time horizon of two to three years, she said.

“If you believe that we are going to come out of this, which I do, and you think the U.S. is the best place to be in a recession, then there are some great sales going on,” she said.

(Reporting by David Randall; editing by Megan Davies and David Gregorio)