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Energy stocks outperformed market indices in 2010

02.01.2011  |  Thinnes, Billy,  Hydrocarbon Processing Staff, Houston, TX

Keywords: [energy stocks] [royalty trusts] [pipeline] [storage] [natural gas] [financial] [economics]

Despite a poor start, 2010 finished as a “wonderful year” for energy investors, with more than 65% of oil and gas stocks delivering positive returns last year, according to a report from IHS Herold. Driven by economic growth, crude prices, which hit bottom in late May 2010 at around $65 per barrel, rose steadily and consistently through the second half of the year, and took oil company shares with them.

The median gain for the 503 stocks covered in the report was 21%, which, while it did not match the record-setting 59% gain posted in the 2009 IHS report, did outperform the market indices of nearly all Organization for Economic Cooperation and Development (OECD) countries. Total capitalization jumped by more than $300 billion, further reducing the severe losses the sector incurred in 2008 the report said, but did not extinguish them.

“Sometime in the first quarter of 2009, equity markets began to move upward in response to the economic growth that was becoming apparent in OECD countries,” said Robert Gillon, senior vice president and co-director of energy equity research at IHS. “It seemed as though every statistic that confirmed expansion was under way was reflected in a rise in the price of crude, which boded well for oil stocks. That pattern continued throughout the year, with oil prices and oil shares at a recovery high at the closing bell of 2010. In particular, North American oil stocks delivered the most returns to their investors.”

Group returns.

After finishing second-to-last as a peer group in 2009, US royalty trusts earned redemption by taking top honors in 2010 as the best-performing peer group reviewed, posting a gain of more than 44%. MV Oil Trust led the group by posting a return of 111%.

Companies in the E&P limited income partnerships group followed closely with gains of nearly 43%. According to the IHS report, these survey-leading returns were in response to monetary stimuli by numerous central banks, where open-market interest rates fell to the lowest levels seen in decades, which forced yield-conscious investors to take on more risk in order to maintain their desired level of income.

“The vast amount of liquidity being injected into the economic system, particularly in the US, has resulted in a strong correlation between equity prices and oil prices,” Mr. Gillon said. “By contrast, for many years prior to 2009, there was a reverse relationship, with higher crude prices perceived to cause a reduction in disposable income, lower consumer spending, and declining domestic product and stock prices. To our mind, this is the normal state of affairs, but to predict we will be back to normal in short order would be unwise.”

As a group, master limited partnerships (mostly pipeline and storage companies) enjoyed a hearty gain of nearly 35%, while the peer group of integrated oil stocks with US downstream returned 22%, which was marginally above the survey average. Canadian integrated oil stocks and integrated oil stocks without US downstream operations gained less than half that amount, at 10% and 9%, respectively. Returns from the latter group, the report said, were dragged down by the generally poor performance of European markets. On the other hand, shares in the refining and marketing category offered a healthy median gain of 38% and did well globally as demand for distillates rose with increasing economic activity.

Among the largest integrated and diversified oils group, top-ranked Ecopetrol’s 84% gain reflected rapidly growing oil production, and it also got an updraft from the soaring Bogotá market. Sunoco Inc. and Valero Energy, last year’s bottom two performers in this grouping, moved into the top 10 due to a dramatic turnaround in refining margins. BHP Billiton is the only member of the 2009 crop to repeat in the top 10 this year.

Natural gas.

While oil stocks carried the sector in 2010, continued weakness in the North American natural gas market did not prevent the large producers from generating solid shareholder returns, with the median performance of the group nearly matching that of the entire survey. However, a high concentration of North American natural gas in the production mix detracted from returns, since US natural gas spot prices, which began the year at what now seems like the lofty price of $6/MMBtu, ended the year at a nine-year low for the date, which was about 30% below where they began.

“Natural gas inventories were well above average, and US domestic production showed no signs of topping out,” Mr. Gillon said. “Fortunately for everyone but the Europeans, it has been ferociously cold in Europe, so gas is being shipped to the higher-priced markets. The world is well supplied with gas, and the modest upward slope to the current futures curve is testimony to the glut in supply.”

Alternative energy.

Stocks in the alternative energy group held the basement position as worst in class, posting losses of more than 24% after gaining 26% in 2009.

“We’re not sure what to say about alternative energy, except perhaps a requiem. In the five years we have shown this segment in the survey, it has been the worst performing group twice, second worst twice, and soared to fourth from the bottom on one happy occasion,” Mr. Gillon said. “They suffer when natural gas prices go down, when government subsidies are cut, when the wind doesn’t blow, when it blows too much, and when the sun doesn’t shine. There may be other problems, as well, which we will probably find out about in 2011.”  HP

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