Running with the energy bulls

A new report from portfolio manager Fayez Sarofim says all signs point to a rebound in energy stocks.

EMAIL  |   PRINT  |   SHARE  |   RSS
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all RSS FEEDS (close)
By Scott Cendrowski, reporter

Best advice I ever got
In a world of uncertainty, we could all use a little advice. So we asked a host of influential leaders to share with us the wise words that changed their lives forever.

CDs & Money Market
MMA 0.69%
$10K MMA 0.42%
6 month CD 0.94%
1 yr CD 1.49%
5 yr CD 1.93%

Find personalized rates:

Rates provided by

NEW YORK (Fortune) -- The signs are there: Crude prices are almost $80 a barrel. Emerging market economies are rebounding. China has resumed its fast-paced growth.

Read those signs, and they point to one conclusion, according to portfolio manager Fayez Sarofim & Co.: You should buy energy stocks.

The Houston-based firm, which manages $18 billion for pension plans, foundations, other groups and individuals, recently released a decidedly bullish long-term energy outlook.

Jeff Jacobe, director of investments at Fayez, expects slowing production at existing oil fields to add to crude prices' rise. Meanwhile he predicts the challenges facing alternative energy sources like wind and solar should keep traditional sources in demand for decades.

To understand what this means for investors, Fortune spoke with Jacobe and analyst Cody Dick., who co-authored the report. Edited excerpts are below.

You say the average portfolio doesn't include enough exposure to global energy companies. Yet, you detail the challenges of aging oil fields. How do you marry those points?

Jacobe: We take a very long-term oriented, low-turnover approach to investing, and we typically try to find the industry leaders in particular sectors. Over long periods of time, those stocks and those companies have delivered the highest returns on capital and generated the most free-cash that is returned to shareholders via dividends and buybacks. Over long periods of time they have also generated above-average returns with less risk than the market.

What those companies bring to the table are capital, technology and project management skills. And while there is a challenge in terms of access, there are still enough places in the world that need these companies to provide them the access. And these companies still have a significantly undeveloped resource base there.

And if you look, they haven't kept up with crude -- the price of crude oil is up 80%. It's more than doubled off the bottom, and stocks like Exxon Mobil (XOM, Fortune 500) are down 9% percent year-to-date. We think that's unsustainable, and they will catch up.

Another company that we hold is Occidental Petroleum (OXY, Fortune 500), which is a little more crude-oil-focused. It's got a very good management team with a history of being very good allocating capital. And recently they've been pretty excited about a field they found in California that will produce both natural gas and crude oil that could be a pretty prolific conventional field in onshore North America.

Is energy output going to keep up with future demand from China, India, and emerging markets?

There's obviously a very high correlation between global GDP growth and energy demand. I'll focus on oil for the moment. We feel that GDP growth in the developing world is going to be the real driver of oil demand, and that going forward, GDP growth outside the U.S. will be higher than inside the U.S.

Global oil demand growth should be about 1% a year, which is below what it's been the previous 20 years. But even with 1% demand growth, you have to also consider that the decline rate on the base -- and that's probably the most important point -- is declining anywhere from 5% to 7% a year. You have to replace that with additional investment.

The way the market is going to balance over the next 10 years to 15 years is through price. $147 a barrel is unsustainable, but so is $35 a barrel. You need something higher to balance the market and bring the necessary investment.

You note that last year the U.S. became the largest producer of wind energy. Can alternatives replace the energy lost to diminishing oil fields?

Dick: In the short term, oil is such a key component of transportation, it's really hard to replace.

The major issue for alternatives is scale. A perfect example of that is in Denver. They were recently celebrating the opening of a solar plant there that produces about 8 megawatts. It was on 82 acres, and it serves roughly 1,600 homes. A typical natural gas power plant needs about 40 acres to produce 1,000 megawatts and serve 200,000 homes.

In addition, wind and solar don't produce things like plastics, and they don't necessarily contribute to transportation fuels at this point. It seems the best option for the U.S. is to have the full menu available. If you plug in your car, then you're getting that electricity from a power plant that might be nuclear, coal, natural gas, but it also might be wind, solar, geothermal or hydroelectric. We need all of those things.

If investors agree with your bullish view, how should they invest in energy?

Jacobe: The best way for retail investors to invest is to have a long-term outlook and try to pick stocks. We would pick the strongest companies from a balance sheet perspective and ones that pay attractive dividend yields that over time generate the lion's share of the profits.

We think that the highest quality of that bunch is the international oil companies. We think [energy] ETFs, index funds, and directly investing in commodities is very risky and tough to do. We think those are not very efficient ways to invest. You want to pick stocks.

You write that over long periods of time, integrated oils have high returns than the market and lower risk. What's a good example?

Typically, there's been a fairly low correlation with the overall market in these stocks. Exxon is probably the best example. It's been a very consistent performer over many, many years.

Even after you take into account the performance year-to-date -- which as I referenced earlier has been lagging -- over 10 years it's returned about 9% a year. The S&P 500 (SPX) is negative 6% in that time. Over 15 years, it's returned more than 13% compounded annually compared to the S&P's 7.5%.

The stock obviously has a pretty high correlation with crude oil prices, but it's an integrated oil company, so it's got refining and chemicals, which provides some downside protection. To top of page

Company Price Change % Change
Ford Motor Co 8.29 0.05 0.61%
Advanced Micro Devic... 54.59 0.70 1.30%
Cisco Systems Inc 47.49 -2.44 -4.89%
General Electric Co 13.00 -0.16 -1.22%
Kraft Heinz Co 27.84 -2.20 -7.32%
Data as of 2:44pm ET
Index Last Change % Change
Dow 26,664.40 236.08 0.89%
Nasdaq 10,902.80 157.52 1.47%
S&P 500 3,294.61 23.49 0.72%
Treasuries .56 0.03 5.04%
Data as of 5:33am ET
More Galleries
10 of the most luxurious airline amenity kits When it comes to in-flight pampering, the amenity kits offered by these 10 airlines are the ultimate in luxury More
7 startups that want to improve your mental health From a text therapy platform to apps that push you reminders to breathe, these self-care startups offer help on a daily basis or in times of need. More
5 radical technologies that will change how you get to work From Uber's flying cars to the Hyperloop, these are some of the neatest transportation concepts in the works today. More
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play

Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.