Ivy Energy Fund
1. Prices Fall, Demand Rises, Supply Gaps
The last four major oil cycles have one thing in common: Falling prices, increasing demand, and pressure on supply. Growing demand and declining supply then tend to push prices higher.
We estimate the world is oversupplied by 1-1.5 million barrels per day (bpd) on total consumption of 94 million bpd and estimate demand growth this year of 1.4-1.5 million bpd, largely driven by lower prices. We think the year-over-year increase in global supply now will start to diminish as Organization of Petroleum Exporting Countries (OPEC) and U.S. shale output are slowing. Even if demand growth slows to a more typical 1 million bpd in 2016, supply growth will need to reaccelerate.
2. Iran May Add Supply
Iran may add 500,000 bpd in the first half of 2016, with perhaps another 500,000 bpd in the second half of the year.
That increase in supply could resolve the expected gap because of steadily increasing demand and prevent price spikes. Depending on the demand environment, we think the supply/demand imbalance will be corrected by the second half of 2016. Looking to 2017-2018, we think capital spending cuts across the industry will continue to affect supply and oil prices will move steadily higher as demand grows.
3. U.S. Shale Poised To Recover
Shale oil producers have significantly cut marginal costs. While all U.S. shale offers opportunities, much of our focus is on the Permian Basin as the place we think production growth is most likely to continue.
The companies in the Permian still are in the early stages of improving efficiency and productivity. They are reducing costs faster than in the other, more mature shale areas. We continue to believe that the huge land area of the Permian versus other shale plays and its multilayer potential make it a massive opportunity for selected companies active there. Given the slowdown in U.S. shale output on the back of lower oil prices, we do think it will be difficult to get U.S. shale growth again by mid-year 2016. The drop in oil prices caused many U.S. exploration & production companies to become more efficient and more productive per well, cutting costs and focusing on the best shale areas and their best wells. We think that will continue in the near term, with the rig count perhaps moving a bit lower. But we think the wheels are in motion to correct the supply/demand imbalance, as noted above, which will mean a healthier environment for shale producers.
4. Oil Majors Challenged
We believe the business model for oil majors – also known as integrated oil companies – is challenged now.
Prior to the OPEC meeting in late 2014, integrated companies were cutting costs and lowering capital expenditures (cap-ex) because it was difficult to be profitable with oil at $100 per barrel. That raises questions about their profit potential now since oil is at much lower prices. In addition, oil majors historically have been viewed as a defensive investment; they have tended to do relatively better when the energy sector falls and relatively worse when it rises. Given our outlook, we do not wish to be defensive now – as most passive, index-based funds are at this point because of the oil majors weighting in the benchmark index. We also think Master Limited Partnerships (MLPs) as a group have challenges now from valuations, slowing U.S. oil production and flattening growth. We do have exposure to feebased MLPs, mainly in our preferred Permian Basin, but do not invest now in upstream MLPs or service/driller MLPs.
5. Bias To High Quality
The Fund is focused now on what we believe are the best companies with the best balance sheets, best oil acreage, low-cost production and ability to grow even in a low-price environment.
We’re seeking names that can survive and even thrive in a low-price environment. We think the valuations of refiners still look attractive and believe U.S. refiners will have a low-cost advantage relative to the global refining market for some time to come. At 22% as of March 31, 2015, the Fund has low portfolio turnover on an absolute basis and relative to our peer group. We believe that, when you’re in a commodity, you must understand the fundamentals and filter out the short-term volatility and noise.
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through Sept. 25, 2015, are subject to change based on market conditions or other factors, and no forecasts can be guaranteed.
Risk Factors: The value of the Fund’s shares will change, and you could lose money on your investment. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification. Investing in the energy sector can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments, and the cost assumed by energy companies in complying with environmental safety regulations. These and other risks are more fully described in the Fund’s prospectus. Not all funds or fund classes may be offered at all broker/dealers.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing this and other information for the Ivy Funds, call your financial advisor or visit www.ivyfunds.com. Please read the prospectus or summary prospectus carefully before investing.
© Ivy Investment Management Company
