If the oil supercycle is dead, do you believe in resurrection? Or reincarnation?

As INO’s Energies contributor, how could I ignore Saudi Prince Alwaleed’s provocative statement that oil will “never” hit $100 “anymore”? In his interview with Maria Bartiromo for an article in Monday’s USA Today, Prince Alwaleed aptly summarized key reasons for today’s low oil prices, but (importantly) he didn’t give offer any evidence that oil would “never” again reach triple digits.

Still, many are decrying the “end of the oil supercycle.” Perhaps the supercycle is dead; or perhaps not. Either way, the world still needs energy from someplace, right? And lots of it! Which path, then, does the future hold? A resurrection of the oil supercycle? Or a reincarnation of a new energy supercycle based on resources other than oil? (Or “all of the above”?).

One prominent money management firm I’ve followed for most of my investment career, WHV Investments in San Francisco, was the first to introduce me to the term “supercycle” – referring to the coming oil- and steel-intensive “industrial revolution” that kicked into high gear in emerging countries in the early 2000s. By way of background, WHV is no “closet indexer.” Its managed portfolios, rather, reflect the firm’s conviction in top-down macroeconomic themes and trends identified by its team of analysts and managers.

In 2000, WHV presciently (and fortuitously) rotated its separately managed accounts (SMAs) from being heavily invested in the technology sector to having a large overweight in energy and materials (in anticipation of the aforementioned supercycle arising from the emerging markets). Seeing many more years of emerging markets expansion and construction ahead, WHV has stuck with its unorthodox allocation to this day, for better and for worse (mostly for MUCH better, until turning mediocre in 2011, and then really taking a pounding since last summer).

How heavily has WHV bet on its belief in an energy supercycle? As of 9/30/2014, Morningstar lists WHV International Equity Fund’s (WHVIX) sector allocation as 33.1% energy (vs. 5.9% for the MSCI EAFE index), 25.4% materials (vs. 8.1% for the EAFE), and 21.1% industrials (vs. 11.5%). Like I said, WHV doesn’t believe in clinging to some arbitrary benchmark. The firm invests according to its true beliefs and expectations. For most of the last couple decades, WHV’s commitment to its core philosophy has paid off. The last several months, however, have been brutal – as is bound to happen sooner or later when any investor sticks with a top-down theme long enough.

Is the energy supercycle dead?

Without further ado, let’s examine WHV’s initial reasons for investing in energy since 2000 (summarized below). I’ve listened to WHV’s portfolio managers re-affirm their conviction as recently as early December 2014. You can be the judge, though, of whether WHV’s themes still have a prayer of ever delivering big-time results again.

Here’s my attempt to paraphrase WHV’s long-standing “dominant global economic forces”:

• Capitalism causes wealth to gravitate to countries with lower costs of land, labor, and capital.
• Emerging countries, therefore, will attract significant capital for many years or decades to come.
• Emerging countries are home to about 6 billion of the world’s 7 billion people. In addition, the world’s population is set to increase by 2 billion by 2040, and much of the increase will occur in emerging countries.
• Emerging countries continue to industrialize, urbanize, and build infrastructure – all of which are energy- and materials-intensive. This “2nd great industrial revolution” is a major secular trend that will last several years or decades, and represents the world’s growth engine going forward.
• Energy and basic materials are long-term supply constrained, in terms of finite supplies, as well as high barriers to entry and long lead times for production.

Do those theses seem out of date? Certainly oil supplies have dramatically shifted with the US shale oil boom in recent years (although somewhat offset by lower production in other regions). Demand and infrastructure development may be (presently) moderate as opposed to robust; but will today’s lower oil prices be just the right remedy to keep things moving?

As another way of stating the supply and demand dynamic, WHV International Senior Portfolio Manager Richard Hirayama recently (in December) described the necessity for the oil industry, generally speaking, to increase its resources by 5% per year just to keep up with demand. About 4% of the 5% increase is required, according to Mr. Hirayama, merely to replace depletion. The other 1% is to meet demand growth. Hirayama calls that 5% hurdle a challenging one for the industry. It means by 2020, he said, the energy industry will need to find about 30 million bbl/day of new growth supplies, based on today’s production of about 93 million barrels per day.

Bottom line, the oil price crash has been primarily attributed to oversupply, weakening demand, and OPEC’s decision to continue pumping. As for supply, it’s a winners and losers game. Some weaker producers go away. Opportunistic surviving companies will fill in the gap. As for demand, the economy will ultimately continue to grow. Consumers will continue consuming, especially at lower prices. Plus wild card factors – such as China ramping up its purchases of today’s cheap crude for its strategic reserves – are in play. At some point, supply and demand will balance at some level, and – perhaps – WHV’s grand theme will resume from that point.

Do these points seem a little crazy or outdated to you? If so, consider what I believe may be the most important point: you’re not the only one who feels pessimistic about energy investing. Pessimism is reaching a high level. At some point, bull markets are born on pessimism.

My advice? Be ready for either a resurrection of the oil supercycle, and/or some form of reincarnation of the grand energy theme.

Resurrection?

My next article (within a week) will reveal some of the best oil companies who have been beaten down the most.

Or reincarnation?

Next week, I’ll turn my attention to non-oil energy investments.

Best,
Adam Feik
INO.com Contributor - Energies

Disclosure: This contributor does not own any stocks mentioned in this article. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.