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posted on 18 November 2015

Why We Don't Own Energy Stocks Now

by Ben Shepherd, Investing Daily

Investing Daily Article of the Week

While you'll find most industries represented in the Global Income Edge portfolios, energy is one which is notably absent, and it's not because it doesn't offer decent yields. You can find high dividends and low ones, just like any other sector, and right now the average yield for an energy dividend payer is an attractive 3.8%. The problem is that most companies in the sector have virtually no pricing power and are at the mercy of the global markets.

Earlier this week crude oil dropped below $45 a barrel for the first time in three months following the monthly report from the Organization of the Petroleum Exporting Countries (OPEC). In it, the cartel said that crude inventories in advanced economies were more than 210 million barrels about the five-year average. That puts inventories at higher levels then during the financial crisis, with the International Energy Agency estimating that there are more than 3 billion barrels of oil in storage around the world.

In one sign of the excess, there are flotillas of supertankers holding station off many of the world's major ports, their only job to store more than 100 million barrels of crude oil and heavy fuels waiting for buyers.

That's enough oil to meet an entire day of global demand. And, unlike during the financial crisis, traders aren't believed to be hoarding the oil to cash in on a recovery; oil producers are simply out of room to store the stuff. That's obviously not good for oil producers, but you could really cash in if you own a fleet of very large crude carriers. According to data from the Financial Times, day rates on those tankers have averaged $60,000 so far this year and spiked over $100,000 in October as available ships have filled up.

Despite the glut of oil on the market, OPEC members aren't showing any willingness to close the tap. Production in Saudi Arabia has risen by about 600,000 barrels over last year to 10.3 million barrels per day in October. In Iraq, production has shot up by 700,000 barrels to more than 4 million barrels per day. All of the members of OPEC combined are currently producing just over 30 million barrels of oil each day, enough to meet about a third of global demand. A new source of supply will also be coming online shortly, with Iran set to ramp up production and boost exports once Western sanctions are lifted next year.

We wouldn't go so far as to say there are no good investments in the energy - in fact, there are lots - we just haven't found any that suit our tastes. We look for companies that have at least some degree of pricing power, which makes dividends so sustainable, and in the weak energy environment there aren't many companies with that.

A big part of the current problem is that there is so little pricing power in the sector, particularly as we have ramped up oil production on our own shores over the past several years, that producers must pump more to make ends meet.

Add in the fact that China's economy is slowing and growth in Europe is anemic at best, we're not optimistic that demand for oil is going to catch up with supply any time soon. Right now, it's forecast that oil probably won't rebound until well into next year at the earliest. So, you're not likely to find any energy stocks in our portfolios any time soon.

That said, low energy prices haven't been all bad. Here in the U.S. the Energy Information Administration has estimated that the typical household is saving $700 on energy costs this year as compared to 2014.

With gasoline prices expected to stay below $3 next year, much of that savings will carry over into 2016. Low energy prices also helped to boost consumer spending, which rose 3.7% in the second quarter of this year and 3.2% in the third quarter. That's helped make the consumer discretionary sector the best performer over the past year with a better than 17% gain.

So while we won't be buying any energy stocks anytime soon, low energy costs aren't all bad.

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