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Funds That Are Betting on Energy Stocks

NEW YORK ( TheStreet) -- Earlier this year, oil prices plummeted, falling from $108 a barrel in March for West Texas Intermediate to $78 in July. In recent weeks, prices have rallied, but the big decline damaged energy stocks. So far this year, energy stock funds have lost 1.3%, while the S&P 500 gained 12.3%, according to Morningstar.

Now, some fund managers argue that energy stocks sell at bargain prices. The bulls say that the market has overreacted to near-term disappointments.

"We are seeing a bottoming of earnings, and the picture will improve in the next year," says Peter Sorrentino, portfolio manager of Huntington Dividend Capture (HDCAX), a large value fund with a big position in energy.

The optimistic managers rest their case on the changing outlook for supply and demand. Earlier in the year, inventories began building. Many investors feared that oversupplies could become worse if the global economy stagnated while new fields produced more oil and gas.

But despite the deepening recession in Europe, global demand has continued to climb as the U.S. economy grows and China avoids a hard landing. The International Energy Agency recently forecasted that global oil demand would grow 1.1% in 2013 to 90.9 million barrels.

While demand increases, supplies are moderating. In July, oil production by Iran dropped by 200,000 barrels a day, as the U.S. and European Union implemented an embargo. The sanctions ban U.S. and European companies from providing insurance for ships carrying Iranian oil. That could discourage exports to Asia.

In the U.S., oversupplies pushed down prices of natural gas, which fell from $4.18 per million Btu in September 2011 to $1.87 in April this year. The U.S. Energy Information Administration forecasts that production will grow 3.8% this year, up from the record level of 2011.

But production should begin slowing. Faced with depressed prices, drillers have pulled their rigs away from gas production and shifted to oil fields. According to oil services firm Baker Hughes, the number of active gas rigs dropped from 936 last October to 505 in July.

While production is slowing, demand for natural gas is increasing, says Will Riley, portfolio manager of Guinness Atkinson Global Energy (GAGEX). Riley says that electric utilities are shifting from coal to gas. "The combination of shifting supply and demand should push gas back into the $3-to-$5 range," he says.

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