energy sector analysis brian r. boulter fisher college of business 2/13/07

Energy Sector AnalysisEnergy Sector Analysis

Brian R. BoulterBrian R. Boulter

Fisher College of BusinessFisher College of Business

2/13/072/13/07

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

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)

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.

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%

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

Oil & The Energy SectorOil & The Energy Sector

*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

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

Commodity Cycles Are Long-Commodity Cycles Are Long-Term Business CyclesTerm Business Cycles

Source: Hess Energy Trading Company, LLC

(Soft Landing)

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!

Global Oil ConsumptionGlobal Oil Consumption

Global Oil SupplyGlobal Oil Supply

Middle Eastern Oil SupplyMiddle Eastern Oil Supply

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.

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

$34

$57

$96

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.

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

Absolute ValuationsAbsolute Valuations

Relative ValuationsRelative Valuations

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

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