Energy Space Still Has Value

The rising cost of commodities is just one of the challenges posed to investors in the energy space, but there is still value in the sector, a Fidelity portfolio manager told attendees of Morningstar's mutual fund industry conference in Chicago.

John Dowd, portfolio manager of the (FSENX Quote)Fidelity Select Energy Service Portfolio (FSENX), was one of three fund managers to speak Thursday morning about what they see as the major trends in the commodity markets and how they structure their funds to capture returns.

"Whether it was aberrantly low price for the past 20 years, or whether it's a structural shift in demand in certain countries, every commodity has been going up," said Dowd. "The cost of building a refinery has doubled, the cost of building copper mines has increased and all have seen underlying inflation. Do I incorporate that into my equation? Yes. Do I want to pay for it? No. I want the companies that will prosper, but won't see the rising costs."

The Fidelity Select Energy Service Portfolio isn't a diversified natural resources fund, but has a broad mandate that allows it to invest in giant-cap integrated oil company stocks. Morningstar gives the fund four stars and calls it the least expensive fund in its category, with an expense ratio of 0.89%. Last year, the fund returned 14%. Through May this year, the fund surged 22%.

Dowd says his fund invests in the stocks of companies in the energy sector rather than the hard assets, because he finds he can buy the equities cheaper than the underlying reserves.

"The market doesn't put a high multiple on a lot of these stocks, valuing them at about 70%," says Dowd. "We're looking for companies that are cheap and good and the management is smart."

Dowd says the frequent mention of commodities in the headlines has led many to think the sector is in a bubble, but he says that's not the case and he continues to find bargains. He says he's bullish on crude oil because much of the increase in Chinese imports of oil has been masked by an almost equal number of exports from Russia. But if Russian supplies can't keep up, an increase in Chinese demand will push prices higher.

And supply is already constrained, says Dowd. Companies are reconsidering plans to build new oil refineries because of the huge jump in the cost of construction, from about $6 billion to $16 billion. On top of that, the Organization for Petroleum Exporting Countries, is under-producing.