The International Energy Agency recently made an announcement stating that demand for all three major fossil fuels will peak within this decade. However, many investors do not agree with this assessment, and the alternative energy sources have their own set of challenges. Surging costs have put key U.S. offshore wind projects at risk, as seen with the recent writedown from Ørsted. Additionally, nuclear projects worldwide are facing several cost and operational issues.
Even if one were to agree that oil is near its peak, the Environmental, Social, and Governance (ESG) movement is limiting the amount of money and drilling locations available. Famous investment author John Mauldin notes that “Economics 101 says that if you reduce the supply of something with increasing demand, the price is going to rise.” Mauldin, who is affiliated with an independent oil and gas operator, believes that reducing the supply of oil through ESG restrictions may lead to rising oil prices.
This has already had an impact on the offshore oil industry, with the VanEck Oil Services ETF (OIH) surging 51% over the past year compared to the 15% gain of the S&P 500. Companies like Weatherford International (WFRD), Transocean (RIG), and Tidewater (TDW) have also seen their stock prices nearly triple in value over the same period. These companies specialize in owning and operating oil rigs, drill ships, support vessels, and providing specialist services in the oil industry.
Rupert Mitchell, author of the Blind Squirrel Macro blog, focuses on these companies with a combined market capitalization of $30 billion. He highlights their high utilization rates, exceeding 90%, and the climbing day rates, which refer to the daily cost of drilling. Despite these positive indicators, offshore companies are currently trading at a substantial discount, often up to 80%, compared to their replacement costs. This has discouraged the construction of new equipment. Shipyards, which have experienced losses in the sector before, are now prioritizing the construction of liquefied natural gas carriers.
According to Mitchell, “No new drill ships, floaters, jack-ups, PSVs, etc., are going to get built until day rates have spent a reasonable amount of time way above current levels.” He predicts that companies with low average age fleets will have more influence over pricing, as the industry waits for day rates to increase significantly.
To minimize portfolio volatility, UBS quantitative strategists recommend holding portfolios consisting of 24 stocks, which would reduce volatility to within 10% of the market’s volatility over the past five years. Similar tests conducted by UBS since 2009 found that the median number of stocks required to achieve this level of reduced volatility was 28. It’s important to note that in these tests, the stocks were chosen randomly without consideration for diversification purposes.
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