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.

To bet on a revival of prices, try an energy fund. A sound choice is Guinness Atkinson Global Energy. During the past five years, the fund returned 0.7% annually, outperforming 86% of competitors. Guinness has 38% of its assets in integrated oil companies, including Chevron ( CVX). The oil giant has a price-to-earnings ratio of 8.4, a modest figure at a time when the S&P trades at 14.

Portfolio manager Will Riley is particularly keen on North American exploration and production companies that focus on gas. Holdings include Newfield Exploration ( NFX). While the company should benefit from rising gas prices, its shares sell for a P/E ratio of only 7.3.

Another solid fund is Ivy Energy ( IEYAX), which returned 0.3% annually during the past five years and outdid 81% of peers. Portfolio manager David Ginther owns Exxon Mobil ( XOM), but he is underweight the big integrated oil companies.

He figures that he can find faster growth in companies that provide equipment and supplies to drillers. One holding is National Oilwell Varco ( NOV), which supplies equipment used on offshore rigs. "Over the next three to five years, we are going to have to build a lot of deep-water rigs to keep up with demand," he says.

A large value fund with a big stake in energy is Payden Value Leaders ( PYVLX). The fund has broken even over the last five years, outdoing 66% of competitors. Payden favors stocks with hefty dividends, and the fund yields a rich 5%.

The portfolio has 15% of assets in master limited partnerships, including companies that own pipelines. The MLPs charge energy companies to transport oil and gas. Their fees rise along with increases in the volume of products passing through the pipeline. Portfolio manager James Wong figures that revenues will increase as demand for energy grows. "The cash flows should continue to be quite strong," he says.

One holding is Enbridge Energy Partners ( EEP), which operates a pipeline that brings oil from Western Canada to the U.S. The shares yield 7.5%.

Huntington Dividend Capture has 15% of its assets in energy. During the past five years, the fund returned 1.5% annually, outperforming 86% of peers in the large value category. The portfolio managers are particularly keen on equipment providers. A holding is Chicago Bridge & Iron ( CBI), which makes equipment that is used to ship liquefied natural gas. The companies are beginning to build facilities that will transport U.S. gas overseas.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.

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