Skyrocketing oil prices are pinching many companies' profits, but energy stocks give you a way to make money in this environment.
That's why we huddled with Ernst von Metzsch, who's built a solid track record managing the
(VGENX)Vanguard Energy fund since its inception 16 years ago. Read on for his favorite stocks in the energy sector, his oil price forecast, and his dismissal of alternative energy companies-some of this year's top performers.
1. Let's start with oil prices, which have hovered at 10-year highs. What's driving prices higher and where do you see them going? von Metzsch: For the first time in a long time, world oil production is reaching capacity. If we go back to the mid-80s, we had various oil crises. At some point, the price of oil had been driven up, and about 14 million barrels a day of excess capacity was created in the world. And that is slowly being eaten up, and on top of that we had the Asian crisis of 1998, which led to a period of very low oil prices and very low drilling. So, with the recovery of demand, the utilization rate has become quite high.
Ernst von Metzsch |  |
Fund
(VGENX)Vanguard Energy |
Managing Fund Since
May 23, 1984 (inception) |
Asset Size
$1.3 billion |
YTD Return / Rank in Category
27.8% / 8 of 24 |
3-Year Return* / Rank in Category
4.7% / 7 of 20 |
Load / Expense Ratio
None / 0.47% |
Top Holdings
ExxonMobil (XOM)
Phillips Petroleum (P)
Anadarko Petroleum (APC) |
| Source: Vanguard, Lipper. Returns through Sept. 21. Holdings through Sept. 19. *Annualized. |
At the moment, the price of oil is unsustainably high. So if market forces were to exert themselves, demand would fall off and supply would increase. But that's a development that might take a year or two to fully play out. In the meantime, as prices rise, many people just like to increase inventories as much as they can, so demand may not be as high as the recent numbers indicate. And so I think there's a good shot that the price of oil might drop $10 by the end of the year to $26 a barrel.
My view is that oil prices will come down at some point and that the market will benefit from that, with the caveat that nobody stirs up any unrest in the Middle East.
2. Oil prices boost some energy companies' profits, but, as we've seen in recent days, rising energy costs can erode profits from many other sectors. What companies are well-positioned to benefit from rising oil prices? von Metzsch: Companies that really directly benefit are oil producers that just produce the oil and then ship it to refineries. They are the direct beneficiaries. The other group that directly benefits is the oil-service industry, because the higher prices make people look for more oil and gas, and so their revenue should benefit from that as well. So those are the two sectors in the energy sector that really benefit.
Among the independents we have a big position in
Anadarko Petroleum(APC). They have a strong position in the U.S.; they've been acquiring companies and also have good exposure to overseas oil production through their investments in Algeria.
Our largest holding is
ExxonMobil(XOM). It's a very well-run company and very well spread out over the world with its operations. The company also has prospects for good production growth through the decade.
We also have a major holding in
Chevron(CHV), which is also an international company with operations slightly differently located than Exxon's. Chevron is well-positioned.
In the foreign area, we have a large investment in a Canadian company called
Imperial Oil(IMO), which has a very strong asset base in Canada and has been quite well-managed over time. And we think of that as a good long-term hold. If you look in the oil front services area, we have a big investment in a company called
Weatherford International(WFT). We think it's quite well-positioned to participate in the increased need for oil field services.
Halliburton(HAL) is another one.
3. Is there any place for someone who focuses on the energy sector to hide when oil prices go down, or do you just have to position your fund the best you can and ride it out? von Metzsch: You can become more defensive. If we saw a big decline coming, we would go out of the producing companies and the oil service industry and go into the integrated sector as much as we could. But having said that, within an energy fund you basically get energy, so if the energy sector does poorly, we will do poorly as well.
Our marching orders are to invest in the energy sector, but we can moderate the impacts of the clients in the sector by becoming quite defensive within the sector, and the energy sector gives you a lot of opportunity to do that.
4. You've raised the allowance your fund has to invest overseas from 30% to 50%. What do you see overseas? von Metzsch: There's always been a number of strong foreign oil companies, like
Royal Dutch(RD). Over time, more and more have come to the fore, and these are companies that weren't public before, and the French and Italian companies have become much more accessible to investors.
Most recently, we added
Petroleo brasileiro(PBR), or Petrobras, to the portfolio. The U.S. is very mature in terms of oil and gas production, and there are better opportunities overseas, so we want to be able to fully participate in that.
The marching order to go to a higher international weighting is at the end of October. So at that time, I will be able to increase the foreign weighting, but there are no plans to shift the portfolio much for now. With very high commodity prices, mature areas like the U.S. certainly offer a lot more opportunity. We will take advantage as time progresses.
5. Much has been made, particularly this year, of "alternative energy" companies, especially in the fuel cell arena. Could you lay out for folks exactly what the companies do, and whether or not you think they will have a long-term impact? von Metzsch: These are companies that are basically coming up with devices where you can use gasoline, but you can also use gas or hydrogen to generate power. And they are working on systems to make that available on a small scale, for an individual house, or for use in a car. But we have no investments in these stocks. They are subject to intense speculation and most of the technologies are not commercially proven, so it will take a long time before any earnings stream can be generated, if ever.
So we think it's interesting to watch, but in the scheme of things, they're not very important for the next five to 10 years.
The fuel cell technology has been around for a long time, it's just that the effort to improve on it has picked up. You take a company that is most advanced in getting fuel cell power for locomotive use; their goal is to have 50 cars use the technology by the end of 2003. And they think they might break even in 2008, so there's a long lead time, and all this depends on the technology working well. The market has been very technology-focused; it's starting to get carried away with this kind of investing.
6. Historically, energy stocks haven't had much correlation with the broader market. Is a fund like yours a way to hedge against rising oil prices or a diversifier for a modest part of an investor's portfolio? von Metzsch: Yes, that's a way of looking at the sector funds. Especially the energy fund, as you mentioned, where the industry specifics tend to be much more important to the stocks than the general market, so rising oil or gas prices or some crisis in the Middle East, all these things affect the energy business more than what happens in the general stock market. Therefore there's a long-term correlation and that is that the energy business cannot do well if the economies don't grow, so in the long run they sort of move in tandem, but there are years where energy does really well with the market doing poorly, and vice versa.
Take 1998: The market did quite well, but energy did quite poorly because commodity prices were so low.
7. A lot of sector managers notice that when their funds do well, cash gushes into the fund and when they go through their normal cycles, cash leaves. Have you experienced that in your fund? von Metzsch: Vanguard basically doesn't market these funds, because they take the attitude that these funds should be bought by people who are sophisticated and know what they're doing. And so the fund is quite stable in terms of its ownership. There's been some inflow money, but I don't have to spend too much time adjusting the portfolio for inflow or outflow of money, so it's at a pretty stable point.
There's always a tendency to want to come in when tightness has emerged in the market.
8. Energy can be susceptible to some unrest in the Middle East. Do you see any trouble on the horizon there? von Metzsch: There's always a fair amount of uncertainty, because there is also very little excess capacity available. The Saudis are sincere in wanting to get the price down, but there are some other producers like the Iranians, who like to keep the price high because they cannot produce any more, and they just try to maximize their revenues.
The Saudis are much more concerned about world stability and their role in the world markets. But then you also have Iraq, which has been shut in, and now produces close to 3 million barrels a day. There's always the concern that Iraq may decide to shut in production, because it doesn't like the euro under which it can export oil.
Iraq is limited by the
United Nations to the extent that it controls its own business. So there's always a chance that something like that will happen. That could do some damage to the general stock market in the short run.
9. If you had to pick three stocks to buy and hold for five years, what would they be? von Metzsch: One would be Exxon, which is one of our three largest holdings. The company is very stable and has a large amount of assets. Also, it will obtain the benefits from the merging with Mobil that will start coming into the income statement over the next couple of years. So that's one I would single out.
I've mentioned Anadarko Petroleum. We think that's a good long-term holding.
The oil service is always a little bit more volatile so it's hard to look at five years, but I like Imperial Oil. That's another one I mentioned before. It has done quite well over the last decade, with a lot of financial discipline, and it has a very sophisticated way of looking at its own assets. I would include it as well.
10. What was the last new name you added to the fund, and the last new name you added to your personal portfolio? The last new name I added to the fund was the Petrobras. That was the most recent addition to the fund, aside from adding here and there to existing holdings.
In my personal portfolio, I don't trade much. We get into these conflicts, so I tend to buy the fund myself. We get into too many conflicts buying stocks for ourselves.
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