The recent fall in the oil price has caused the share prices of solar stocks to fall. This fall is indicative of a growing negative sentiment towards energy investing, but is not supported by rational analysis of the economics of the solar industry.
When considering the economics of unsubsidized solar, the main competitors are utilities whose retail electricity prices are rarely driven by oil prices. Just 10% of world electricity is generated by oil, and much of that is in the Middle East who would benefit more by exporting their oil for hard currency. The big drivers for electricity are the costs of natural gas, coal and nuclear power. The cost of these has not fallen, and the cost of building new plants, particularly nuclear, is now considerably higher than it has been historically. The oil price is not a driver of the solar sector, and solar’s basic economics do not support the fall in solar companies’ share prices, which is why we think now is an attractive time to own solar company shares.
The main drivers of installation growth are the dramatic fall in installation costs and ambitious subsidy programs in China, Japan and the US. Behind those are an increasing number of countries where unsubsidized installations work at current installation costs, including India, the Middle East and much of Africa.
The International Energy Agency (IEA) recently predicted in their 2014 Technology Roadmap: Solar Photovoltaic Energy that solar energy would account for 16% of the world’s electricity by 2050. While this forecast shines positive light on the industry, we think it actually underestimates how much photovoltaic (PV) solar could be installed and by possibly a considerable margin.
It is always difficult to predict the uptake and transition to new technologies. However, we believe that the IEA is being cautious in their approach. Total annual solar installations have already exceeded IEA targets for 2020 – seven years ahead of schedule and just four years after they were made. As a result, IEA forecasts have increased from 11% of global electricity generation to 16% of global electricity generation. It is notoriously difficult to make accurate long-term forecasts when an industry is in the middle of a growth phase like the one solar energy is going through now, and we think it is likely that the acceleration will continue, and in turn, the estimation will likely increase from here. We think the solar industry is similar to the personal computer and cell phone industries where expected growth has been repeatedly exceeded.
In the 2014 report, utility costs are forecast to fall 30% between 2030 and 2050. However, the 2030 price levels forecasted ($1,000 per kilowatt peak – kWp) are nearly being realized for some Chinese installations. Best in class prices being achieved internationally are approximately $1,170 per kWp. However, installation prices in many countries, including the US, are still more than double those being achieved in China. For example, in the third quarter, Solarcity reported a cost of installation of $2,900 per kWp, which included $710 per kWp of sales, general and administration costs. This means that in many countries the industry has significant scope for cost reductions without requiring the core technology (i.e. the modules and inverters) to improve in performance and price. Installers and financiers in those countries should be able to achieve further meaningful cost reductions by adopting international best practices.
We think solar could be installed at $1,000 per kilowatt (kW) in most countries by 2020, ten years prior to the IEA’s expectations. Extrapolating the potential cost reductions is probably not a realistic approach, but we think it would not be unreasonable to anticipate a halving in that price to $500 per kW by 2050. Pricing at $500 per kWp would allow for competition with utility pricing in many countries. For example in the US, payback of the $500 per kWp installation cost could be achieved in 10 years with pricing of 3.3 cents/kilowatt hour (c/kWh), which compares favorably to both retail and utility prices for electricity.
Current estimates of 2014 solar installations have increased seven-fold since 2008. Elon Musk, CEO of Tesla Motors and Chairman of SolarCity, has forecasted 400 per gigawatt peak (GWp) of installations per year which would be approximately 4% of global electricity generating capacity. 400 gigawatt (GW) of annual expenditure on solar at $500 per kWp would result in $200 billion per year of solar installations in 2050. This compares to IEA estimates of an average of $420 billion per year of annual investment in electricity generating plants across all technologies. We don’t think it is unreasonable that solar could possibly account for 50% or more of annual investment in new electricity generating plants.
We cannot predict exactly how big the solar industry can become, as we are still learning how to make the best use of our solar resource. However, it appears that solar has reached a tipping point in scalability and cost, and we can very easily see an industry 10 or more times bigger than what we have today.
This growth potential is what solar investors should be focused on –we believe that investors can look forward to a decoupling in returns from conventional energy prices as companies benefit from that potential growth over the next three years and beyond.
The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus and summary prospectus contains this and other important information about the investment company, and it may be obtained by calling 800.951.6566 or visiting gafunds.com. Read it carefully before investing.
Mutual Fund investing involves risk. Principal loss is possible. Investments in foreign securities involve greater volatility, political, economic and currency risks and differences in accounting methods. These risks are greater of emerging markets countries. Non-diversified funds concentrate assets in fewer holdings than diversified funds. Therefore, non-diversified funds are more exposed to individual stock volatility than diversified funds. Investments in derivatives involve risks different from, and in certain cases, greater than the risks presented by traditional investments. Investments in smaller companies involve additional risks such as limited liquidity and greater volatility. The Fund’s focus on the energy sector to the exclusion of other sectors exposes the Fund to greater market risk and potential monetary losses than if the Fund’s assets were diversified among various sectors. The decline in the prices of energy (oil, gas, electricity) or alternative energy supplies would likely have a negative effect on the fund’s holdings.
Opinions expressed are subject to change, are not guaranteed and should not be considered investment advice.
Past performance does not guarantee future results.
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OPEC’s Thanksgiving
The Organization of the Petroleum Exporting Countries (OPEC) meeting ended on 11/27/14, Thanksgiving Day, with the decision to leave their production quota unchanged and no clarity on when a cut might be forthcoming. The lack of any quota cut, combined with little indication that OPEC were particularly focused in the short term on quota compliance, caught the market by surprise. Crude oil prices and energy equities fell sharply.
We have reflected on the meeting outcome and its implications.
Are OPEC dysfunctional or is Al Naimi of Saudi just being savvy?
We think probably the latter, and reiterate two important criteria for Saudi:
- Saudi is interested in the average price of oil that they get; they have a longer investment horizon than most other market participants
- Saudi wants to maintain a balance between global oil supply and demand to maintain a price that is acceptable to both producers and consumers
On further analysis, Saudi’s decision to not shoulder an OPEC production cut is consistent with both of the above objectives.
We were not particularly surprised at the ‘no cut’ decision from OPEC, but we had not expected the lack of clarity in their accompanying comments nor the size of the market reaction.
The average price of Brent in 2014 will be around $100, even if it averages $70 for the rest of the year. If it stays at $70 until April, then averages $90 until December 2015 and then $105 in 2016 and 2017, the average for 2015-17 would be just under $98 per barrel – a reduction that they would hardly notice. We believe that Saudi went to the meeting perfectly willing to cut production to put a floor under the price but were unwilling to take the responsibility alone. While Kuwait and the United Arab Emirates (UAE) would have likely supported such a move, in our opinion, agreement from other members of OPEC about the size of the cut and who within OPEC should shoulder the burden was clearly not forthcoming. With Libya suffering civil unrest, Iranian production depressed by sanctions and Iraq still recuperating, there was clearly not enough cohesion among the other countries to generate a consensus. Saudi still no doubt has a vivid memory of the 1982-1985 period when it was the only OPEC member pulling its weight and took production down to 3 million barrels per day when its capacity was around 10 million barrels per day. In the face of improving non-OPEC supply this time, Saudi clearly does not want to play the role of the lone ‘central banker’ again.
So $78/bbl Brent, as it was at the time of the meeting, was not enough to galvanize the group to make a unanimous decision about production. Crude oil fell by nearly $10 per barrel in the subsequent days; maybe that is enough to see a change of opinion? It is certainly a level which should remind high spending US shale oil companies (as well as some of their more errant OPEC colleagues and Russia) of the need for more capital discipline. If oil prices do not find a floor in relatively short order, we would expect to see an unscheduled OPEC meeting called with an emergency quota reduction and an actual physical reduction in oil supply thereafter.
In terms of informational content, we noted that there was no mention this time of OPEC supporting $100 oil as a sensible oil price for both producers and consumers. This does not change our long-held $100 per barrel long term oil price view (it is driven by economic analysis rather than OPEC commentary), nor our belief that OPEC favor $100 long term.
That said, we sense that Saudi & co. are eyeing US shale oil production growth and would prefer a shallower oil price recovery for the time being, rather than a ‘V’ shaped recovery, i.e. one that doesn’t allow US oil growth to accelerate unabated. If we are right, it is logical for Saudi to tolerate a lower oil price for months rather than weeks.
Analyzing the decision of OPEC not to cut production quotas, it may well be that they are more comfortable with current supply/demand dynamics than many commentators are. Even on current estimates (pre-this period of lower oil prices), the International Energy Agency (IEA) expected second half 2015 supply/demand to be broadly in balance after a period of oversupply in Q1 2015. Real time indicators, such as Asian refining margins and Middle East to Asia tanker rates, are moving in line with season norms and broadly in line with historic ranges – there is no data indicating particular demand weakness in the oil market currently. This does not appear to be a re-run of 2008/09.
So, in all likelihood, Saudi (together with Kuwait and the UAE who are working well together) will probably keep production unchanged (and hence prices in the $60-80 range) until they see signs of capital discipline, particularly in the US. Note their aggregate production is around 15.5 million(m) barrels(b)/day, which is 2.65 million b/day above the level of 12.85 million b/day at the end of 2010. Because many Exploration & Production (E&P) companies have a fair amount of forward oil production hedged, we would expect this stance from OPEC to last for six months or so. Only then, once discipline has been reinstated, will they likely cut production to bring the price back up. North American E&P companies, ironically, should be very grateful to them – some pain now could lead to gain in later periods as investors find their worst fears of a collapse in the oil price much reduced.
What happens to oil supply in a lower price environment?
While oil demand looks fine, and will likely be buoyed by lower prices, we note that the global oil balance has loosened in recent months due to accelerating non-OPEC supply. A key question now is the reaction of non-OPEC supply to those lower prices, should they persist.
With US shale oil, we are in new territory. What we do know is that North American E&P companies live hand to mouth, converting one year’s cash-flows into next year’s capital spending. In 2014, capital expenditure (capex) is likely to be 15% higher than initially expected as a result of oil prices being higher than expected over the year (West Texas Instrument (WTI) likely to average $95 per barrel). Our estimate of US onshore production growth in 2014, accordingly, has gone from 0.8m b/day to 1.2 m b/day. So; 15% more capex brought 400,000 barrels per day of extra peak production. This is the marginal near term investment of the global oil and gas industry and is sufficiently ‘short cycle’ in its nature that we should see a capital spending reaction come through pretty quickly.
Assessing the speed of US oil supply response is difficult, but we thought we would highlight sensitivity analysis carried out very recently by Tudor Pickering Holt which shows:
- A flat $80 WTI oil price from here would drive a drilling rig reduction of about 200 rigs and slow growth in US oil production to 0.7m b/day in 2015 and 0.4m b/day in 2016 (vs 1.2m b/day in 2014)
- A flat $70 WTI oil price from here would drive a drilling rig reduction of over 500 rigs and slow growth in US oil production to 0.6m b/day in 2015 and to nearly zero in 2016 (vs 1.2m b/day in 2014)
So far, we have witnessed capex budgets for 2015 that are down around 15% from Continental Resources, 25% from Apache and 50% from Denbury Resources. Moreover, Apache is expecting to cut its rig count by around 50% in 2015. These are pretty dramatic cuts, and we expect to see a lot more announcements of similar size over the next 2-3 months.
We see Russian oil production already starting to roll over, even before lower prices have had a chance to bite. The Russian situation is worsened by sanctions; we are told, for example, that it is currently close to impossible to raise financing for new seismic activity. Lukoil have already announced a 13% cut to 2015 capex. A combination of the effect of sanctions and a lower oil price could easily result in Russian production down by 0.5m b/day over the next 12 months.
Elsewhere, Brazil is likely to be a brighter spot for production, but the rest of non-OPEC will likely start to struggle further. Recall that in the aftermath of 2008/09 downturn, even though the fall in the oil price was brief, non-OPEC supply outside North America had shifted into decline by 2011.
What does this add up to for oil and equities?
We expect oil to trade in a $60-80 range in the near term. This is an unsupported level which may fluctuate significantly. If this price range persists, we expect North American unconventional supply growth to slow rapidly. And we expect OPEC to announce production cuts by late summer 2015 at the latest, if the physical market is not rebalancing quickly enough. This points to a possible rise in oil prices in the second half of 2015.
Longer term we think oil would likely recover to $100/barrel(bbl), possibly by the end of 2016, then we predict that it would inflate with the world economy, growing at 3% in real terms.
Clearly one’s view of energy equity valuations is dictated by future oil price assumptions. Energy equities have traded off sharply in sympathy with the recent fall in the oil price, such that they appear to discount a long-term crude price of around $70/bbl.
If oil eventually settles back at around the $100 level, we now see a potential upside in the sector of around 50%.
Jonathan Waghorn
Portfolio Manager, Guinness Atkinson Global Energy Fund
Opinions expressed are subject to change, are not guaranteed and should not be considered investment advice.
Mutual fund investing involves risk and loss of principal is possible. The Fund invests in foreign securities which will involve greater volatility, political, economic and currency risks and differences in accounting methods. The Fund is non-diversified meaning it concentrates its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. The Fund also invests in smaller companies, which involve additional risks such as limited liquidity and greater volatility. The Fund’s focus on the energy sector to the exclusion of other sectors exposes the Fund to greater market risk and potential monetary losses than if the Fund’s assets were diversified among various sectors. The decline in the prices of energy (oil, gas, electricity) or alternative energy supplies would likely have a negative effect on the fund’s holdings.
The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus and summary prospectus contains this and other important information about the investment company, and it may be obtained by calling 800.951.6566 or visiting gafunds.com. Read it carefully before investing.
Click here to view all the current holdings for the Guinness Atkinson Global Energy Fund.
Global Energy Fund HOLDINGS (as of 10/31/2014)
1. BP PLC 3.69% 2. Suncor Energy Inc. 3.66% 3. Chesapeake Energy Corp. 3.57% 4. Total SA 3.56%
5. PetroChina Co. Ltd. 3.55% 6. Royal Dutch Shell PLC 3.54% 7. Helix Energy Solutions Group Inc. 3.53% 8. Gazprom OAO 3.53% 9. Exxon Mobil Corp. 3.52% 10. ShawCor Ltd. 3.50%
Fund holdings and/or sector allocations are subject to change and are not buy/sell recommendations.
Capex is the capital expenditure, or the funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment in order to maintain or increase the scope of their operations.
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The world is fundamentally dependent on energy for economic growth and human progress, and this is unlikely to change. Global energy demand is projected by the International Energy Agency (IEA) to grow steadily over the coming years and future decades as population grows and per capita energy demand continues to rise. Emerging market population growth, together with higher levels of industrialization, urbanization and personal transportation will likely be the key drivers of this theme. While efficiency measures in developed markets could cap the rate of global energy demand growth, it is unlikely that they will be enough to offset a looming energy supply issue.
Based on IEA projections, traditional sources of energy will still be required to help satisfy this demand growth, and we think that crude oil, natural gas and coal could deliver most of the expected global demand growth in the coming years. Advances in technology could allow renewable and alternative energy sources to gain market share, and environmental issues will probably cause demand to switch away from hydrocarbon fuels towards these new sources of supply. All this will take time, but it has already started to happen.
The problem is that the oil and natural gas industry is basically unable to satisfy this demand growth. As it stands today, spare capacity in global oil production is limited to that held by Saudi Arabia, Kuwait and the United Arab Emirates (UAE) – and we believe it is probably less than 1 million barrels per day. The production from oil fields declines naturally every single day, and oil companies invest hard to offset these natural declines and to maintain steady production. With global production of around 92 million barrels per day, we estimate that the industry needs to replace around 6 million barrels of oil per day every year just to maintain current production levels. This alone is a Herculean task for the oil industry and yet, in addition, the oil industry needs to satisfy growing global oil demand.
The oil industry has been in the limelight a lot more in recent months, and it is fair to say that the sector gets more than its fair share of exposure to geopolitical issues around the world. With a large share of global oil production coming from the Middle East, Africa, Latin America and Russia, it is not surprising that the oil price and the valuation of oil equities can react sharply in the short term to major world events. In the last five years, the industry has had to deal with oil spills, industrial accidents, nationalizations, tax increases, civil wars, sanctions and invasions. These types of unpredictable events have generally caused short term crude oil and share price volatility. Some of it has produced positive results for the sector and some of it negative.
Timing an energy investment can be particularly difficult. For instance, the MSCI World Energy Index outperformed the MSCI World Index by 20% between September 2010 and April 2011 and then underperformed the broad market (i.e. MSCI World Index) by 10% in the subsequent five months. This market fluctuation came primarily as a result of geopolitical events rather than company, sector or market events. However, looking through the short term volatility, the MSCI World Energy Index is up by 11.4% over the last five years, ending 07/31/2014, as OPEC (Organization of Petroleum Exporting Countries) spare capacity has dwindled and the oil market has steadily become tighter. And remember – all this has happened while US oil production has rebounded sharply as a result of the development of shale oil resources.
Even if the US adds a further 3 million barrel per day of new shale oil production into the market over the next three to five years, we still believe that the global oil supply/demand should be finely balanced and that crude oil prices should remain at the high end of their recent range – to incentivize new investment in production capacity and to temper global oil demand growth.
The Guinness Atkinson Global Energy Fund (GAGEX) is designed to reap the potential benefit from these key dynamics and its objective is to deliver long-term appreciation of energy equities, focusing on the oil & gas sector. Our #1 ranking for 10 year performance in the Lipper category, Global Natural Resources, supports our long-term strategy & goal. GAGEX was ranked 1 out of 40 funds for the 10 year period in the Global Natural Resources Lipper category based on total returns for the period ending 6/30/14. For the same period ending 6/30/14, the fund ranked 5 out of 147 funds for 1 year, 21 out of 126 funds for 3 years, and 7 out of 106 funds for the 5 year period.
‘Market timing’ is a tough business, and we don’t claim to be experts at timing at all! What we do know is that the energy sector has produced positive returns over the long term. For example, the MSCI World Energy Index has delivered a total return of 10.9% per annum (pa) version MSCI World Index delivering 8.2% pa over the ten years ending July 31, 2014, and MSCI World Energy Index delivered a total return of 11.3% pa vs. the MSCI World Index delivering 7.2% pa over the eighteen years ending July 31, 2014. We also know that the outlook for the energy industry supports further sustained long term energy demand, as supported by the IEA, which should correlate positively for energy investments. We think that using a diversified, professionally managed portfolio of energy equities is a sensible way of gaining consistent, through cycle exposure to the sector. Complementing the argument for long term allocation, we note that sentiment has improved towards the energy sector in recent months, but the sector is clearly still out of favor. We believe that the combination of a long term positive outlook plus near term poor sentiment might offer a particularly attractive entry point at the moment.
Jonathan Waghorn
Portfolio Manager
Guinness Atkinson Global Energy Fund
Past performance is not a guarantee of future results. Index performance is not indicative of fund performance. For current fund performance, please visit www.gafunds.com.
Opinions expressed are subject to change, are not guaranteed and should not be considered investment advice.
Mutual fund investing involves risk and loss of principal is possible. The Fund invests in foreign securities which will involve greater volatility, political, economic and currency risks and differences in accounting methods. The Fund is non-diversified meaning it concentrates its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. The Fund also invests in smaller companies, which involve additional risks such as limited liquidity and greater volatility. The Fund’s focus on the energy sector to the exclusion of other sectors exposes the Fund to greater market risk and potential monetary losses than if the Fund’s assets were diversified among various sectors. The decline in the prices of energy (oil, gas, electricity) or alternative energy supplies would likely have a negative effect on the fund’s holdings.
The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus and summary prospectus contains this and other important information about the investment company, and it may be obtained by calling 800.951.6566 or visiting gafunds.com. Read it carefully before investing.
Lipper Analytical Services, Inc. is an independent mutual fund research and rating service. Each Lipper average represents a universe of Funds with similar invest objectives. Rankings for the periods shown are based on Fund total returns with dividends and distributions reinvested and do not reflect sales charges.
MSCI World Energy Index is an unmanaged index composed of more than 1,400 stocks listed on exchanges in the U.S., Europe, Canada, Australia, New Zealand and the Far East. The MSCI World Energy Index is the Energy sector of the MSCI World Index.
The MSCI World Index with net dividends is an unmanaged, free float-adjusted market capitalization weighted index that is design need to measure the equity market performance of developed markets. The MSCI World Index consists of 24 developed market country indices. This index includes dividends and distributions net of withholding taxes, but does not reflect fees, brokerage commissions, or other expenses of investing.
One cannot invest directly in an index.
Diversification does not assure a profit nor protect against loss in a declining market.
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We are often asked, how important is meeting management of the companies we invest in?
We do not generally consider meeting management as a high priority, nor a prerequisite for investment, as some do. We much prefer to focus on the objective metrics of a company such as long-term profitability, balance sheet metrics, valuation etc. There are two main reasons for this. First, it is impossible to assess the impact of management or quantify the degree of success or failure that should be attributed to management in any objective way. Second, meeting management can put your objectivity at risk.
There are various questions which we have to ask ourselves, such as how well can we assess management of a company? Can we measure it? What makes good management? Are we any good at sifting out the good from the bad?
How much influence do senior management really have on the future prospects of a company? Intuitively, it seems likely that they are very important. After all, they are the people responsible for setting the goals and strategy for the company and ensuring its implementation. They make significant decisions about how capital is employed, the level of employee headcount, etc., which can all have a significant bearing on the future prospects of a company.
Given that management are the public face of the company, people often attribute company successes and failures to management. The media love to praise management when the company is performing well and criticize them when the company is performing poorly. However, there are clearly many other factors, be they macro, industry-specific or company-specific that could, individually or in combination, have a stronger effect on the prospects of a company than the decisions of management. Therefore, we think too much emphasis is often attributed to management decisions.
Mathematically it’s impossible to isolate the degree of impact that management has on financial metrics and show causation. Even if we did have a suitable metric to use, what would be the appropriate period over which to assess performance and when should it begin? Many of the big capital budgeting decisions that management make will not have a noticeable effect for perhaps a year, two years or more. Therefore, we wouldn’t be able to objectively assess management without a considerable time lag.
So, we can’t quantitatively deduce the degree of success or failure of a company that should be attributed to management. But perhaps we could make a qualitative assessment of management’s value?
What is good management?
Lots of books have been written that profess to define what the key tenets are that make a good manager. They tend to be based on studies that show that most of the senior managers shared X number of skills or characteristics, therefore to identify good management you have to identify the people who have these X number of qualities. These characteristics will likely make sense because they support one’s existing notions of what makes a good manager: bold, visionary, shrewd, decisive, good under pressure, organized, level-headed, etc.
At the same time, many books have been written that attribute successful businesses to individuals, perhaps the maverick who did everything differently to the commonly held idea of good management. They explain the effect their personal experience had on their business philosophy. They discuss the key people that influenced them and why. They explain important decisions they made to which they attribute their success. The books are often packed with proverbs, aphorisms and insights that are all interesting and intuitively make sense.
However, what these books really provide are simply good stories: stories that appeal to the way our brains function. They provide clear, rhetorical, definitive arguments, often stated as “facts” or truths. They may appeal to our existing beliefs, creating emotional resonances which confirm the “truths” we already know.
Much of the role of management when they meet investors is that of a salesperson. They are trying to sell a good story about the company. They attempt to provide a persuasive and appealing story that would resonate with our way of thinking to convince us that they are in control of the company’s destiny, that the value of the company will increase and therefore we should buy their shares. They aren’t going to provide us with the highly complex, conflicting, uncertain, uncomfortable reality, that there is much outside of their control. Who would want to buy that?
We therefore have to be very careful about listening to what management tell us. We need to be clear what is fact and what is opinion.
What is an expectation or forecast and what is real and present?
This is an incredibly important and somewhat uncomfortable realization: in many instances when analyzing aspects that affect the future prospects of a company, not just management, all we can genuinely conclude is, “we don’t know”. We can’t rely on predictions and forecasts, we can’t rely on an elegant, optimistic story that “makes sense”. While uncomfortable, it is vital to realize this, and it focuses the mind away from what we think we know towards what we don’t know, i.e. away from attempting to make predictions and forecasts based on unprovable qualitative factors but instead towards the risks of our decisions. This uncertainty makes us prefer a strong balance sheet today over expectations of earnings growth in the future, diversified established product offerings over hot new products, cash over earnings, and companies that have been successful in most economic and industry scenarios.
Evidence suggests that all of us as have a human psychological bias towards confident statements over balanced statements, certainties over probabilities, simplicity over complexity. Just look at the media: they make strong assertions, condense complex issues into bite-size chunks, and make clear conclusions. This makes it easier for our minds to understand, remember and make sense of the world. Our minds naturally use stories to make sense of our world in any situation where there is conflicting information as our way of dealing with what psychologists term Cognitive Dissonance. Conflicting information is everywhere when you are trying to decide whether to invest in a company – arguments both for and against. We need to be aware that our mind’s natural desire to resolve cognitive dissonance towards a certainty can be an obstacle to making good decisions, and meeting management does not help us maintain our objectivity.
As Mark Twain said, “It’s not what you don’t know that kills you, it’s what you know for sure that ain’t true.”
Matthew Page, CFA
Co-manager, Guinness Atkinson Inflation Managed Dividend Fund
and Guinness Atkinson Global Innovators Fund
Opinions expressed are subject to change, are not guaranteed and should not be considered investment advice.
This information is authorized for use when preceded or accompanied by a prospectus. The prospectus contains more complete information, including investment objectives, risks, charges and expenses related to an ongoing investment in The Fund. Please read the prospectus carefully before investing.
Diversification does not assure a profit nor protect against loss in a declining market.
Mutual fund investing involves risk and loss of principal is possible. Investments in foreign securities involve greater volatility, political, economic and currency risks and differences in accounting methods. These risks are greater for emerging markets countries. The Inflation Managed Dividend Fund also invests in medium and smaller companies, which will involve additional risks such as limited liquidity and greater volatility. The Fund may invest in derivatives which involves risks different from, and in certain cases, greater than the risks presented by traditional investments. The Global Innovators Fund is non-diversified meaning its assets may be concentrated in fewer individual holdings than diversified funds. Therefore, the Fund is more exposed to individual stock volatility than diversified funds.
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Iraq Crisis impact on oil
The rise and rapid expansion of the Sunni enclave known by its new rulers under Abu Bakr al-Baghdadi as the Islamic State of Iraq and al-Sham (or ISIS; al-Sham means greater Syria) comes as no great surprise.
No-one can predict how far it can expand or how quickly it will be crushed (if ever).
Our tentative view is that it is reasonable to assume it will not be defeated any time soon, as support from the disaffected general Sunni Iraqi population will likely be considerable. This reflects the blatant sectarianism of Nouri al-Maliki, the Shiite Iraqi prime minister, since the US left Iraq two years ago. But it will likely be contained in the area it currently controls, and will rule over this area centered on Jazeera and covering much of Western Iraq and Eastern Syria for quite some time.
Current oil production in Iraq of perhaps 3.25 million barrels per day (b/d) includes roughly 150,000 b/d in the central region, which will likely be totally disrupted. The 700,000 b/d production in the north and 2.4 million b/d in the south, however, should be unaffected, provided the conflict does not expand seriously either through Baghdad or into Kurdistan. The immediate effect on oil supplies will therefore be the loss of 150k b/d.
An unexpected, balancing consequence may well be a settlement of the long-running Baghdad Kurdistan dispute and a commencement of unhindered exports of oil from Kurdistan. This depends, of course, on the relevant pipelines surviving and operating, but this is not so impossible as ISIS and Kurdistan, both Sunni, may choose to live in an uneasy acceptance of each other. This would, ironically, potentially release for export 150,000 b/d of shut-in production in Kurdistan.
If we are right, the immediate effect on world oil supply will be surprisingly modest. A more likely consequence is that the general uncertainty will greatly hamper efforts to grow Iraqi production in the south. The loss of a rise in Iraqi production and exports is enough to justify the current move up in the oil price by $5 per barrel, but there is no logical reason why it should rise much more.
Another consequence of this development may be to encourage the transfer of control elsewhere in the Middle East to similar extreme Islamic hands, e.g. in Libya. A major emerging figure there is Mohommad Zahawi, Islamisist leader of Ansar Al Sharia in the east of Libya, which is preventing any significant resumption of Libyan oil exports. On the other hand the emergence of murky ex-Gaddafi General Khalafi Haftar as a Sisi-like dictator (Egypt’s new dictator) may trump that.
One final consequence of a successful establishment of ISIS that should not be entirely discounted is the possibility it destabilizes Saudi Arabia. A recent press comment read as follows:
The kingdom has good reason to fear the revival of an al-Qaida-like group with wide territorial ambitions. The government claims to have broken up a terrorist cell in May that had links to both ISIS and al-Qaida in the Arabian Peninsula. ISIS has also reportedly launched a recruitment drive in Riyadh.
That would be really earth-shaking. No-one is discussing it, but if Saudi now turns against ISIS – a quite likely development – we should not rule out that ISIS survives and garners Wahhabi support inside Saudi Arabia and topples the monarchy. That would be disruptive.
Opinions expressed are subject to change, are not guaranteed and should not be considered investment advice.
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Mutual fund investing involves risk and loss of principal is possible. The Fund invests in foreign securities which will involve greater volatility, political, economic and currency risks and differences in accounting methods. The Fund is non-diversified meaning it concentrates its assets in fewer individual holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility than a diversified fund. The Fund also invests in smaller companies, which involve additional risks such as limited liquidity and greater volatility. The Fund’s focus on the energy sector to the exclusion of other sectors exposes the Fund to greater market risk and potential monetary losses than if the Fund’s assets were diversified among various sectors.
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There is no question that innovation has become an overused buzz word. Search the NY Times and you’ll see that there are 15,900 results for the term innovation in the past 12 months. Google produces 131 million results for the word, and a book search at Amazon produces 64,238 results. Innovation could technically be applied to anything that is simply new, and because it so commonly is, we are inundated with claims of innovation everywhere we turn. However, there is an underlying assumption that a true innovation will not just be new but transformative, invoking positive change to our lives.
Innovation matters. It is paramount to the continual growth and evolution of the world we live in. Innovations like the plow, steam engine, production line and computer, have spurred major economic and societal advancements. Medical innovations like antibiotics and vaccines have made our lives healthier and happier. Innovations like the telegraph, cable and the world wide web have connected lives throughout the world. These are a few of the many ways innovation has spurred human progress.
Innovation matters tremendously in business. Research indicates that innovators have a competitive edge in the marketplace, and we have seen a competitive edge manifest itself in superior financial results and stock performance1. This probably isn’t a surprising conclusion and may explain the cultural obsession with innovation. But the truth of the matter is, it isn’t that easy. Innovation isn’t something easily obtained, and being innovative takes a lot more than simply proclaiming oneself as such. True innovation is actually quite rare, which is why, like many rarities, it can be quite valuable.
To be an innovative company, innovation must be a key attribute of the culture. Innovative companies typically exhibit innovation throughout their business, for example, customer service, employee relations, or innovative product development. One key attribute often shared by innovative companies is a focus on the customer and using innovation to enhance the customer’s value or experience. Increasing value to customers clearly benefits the consumer, but it often also produces greater profits. Some companies occasionally exhibit innovative behavior, most notably with groundbreaking products, but if innovation isn’t a key cultural characteristic, then such companies struggle to be truly innovative.
We’ve gained a bit of experience about innovative companies by managing the Guinness Atkinson Global Innovators Fund for the past 15 years. A lot of thought has been put into our approach to identify innovation and innovative companies, which we share in our recent research report, Innovation Matters. We are also proud of the Fund’s recent ranking as the number one fund in the Global Large-Cap Growth Lipper category for the 1, 3, 5 and 10 year time periods ending this quarter (3/31/14) based on fund total returns; a claim no other equity fund can make for the same period.
Lipper Rankings for the category
Global Large-Cap Growth
| Time Period (as of 3/31/14) | Rank |
| 1 year | 1 of 100 |
| 3 year | 1 of 75 |
| 5 year | 1 of 71 |
| 10 year | 1 of 42 |
Rankings for the periods shown above are based on Fund total returns.
Dr. Ian Mortimer, CFA & Matthew Page, CFA
Guinness Atkinson Global Innovators Team
1 For more information, read our Innovation Matters whitepaper.
Past Performance does not guarantee future results.
Mutual fund investing involves risk and loss of principal is possible. Investments in foreign securities involve greater volatility, political, economic and currency risks and differences in accounting methods. These risks are greater for emerging markets countries. Non-diversified funds concentrate assets in fewer holdings than diversified funds. Therefore, non-diversified funds are more exposed to individual stock volatility than diversified funds. The Fund also invests in smaller companies, which will involve additional risks such as limited liquidity and greater volatility. The Fund may invest in derivatives which involves risks different from, and in certain cases, greater than the risks presented by traditional investments.
Lipper Analytical Services, Inc. is an independent mutual fund research and rating service. Each Lipper average represents a universe of Funds with similar investment objectives. Rankings for the periods shown are based on Fund total returns with dividends and distributions reinvested and do not reflect sales charges.
The Ukraine-Russia crisis, as well as Russia’s position as a major energy provider, has renewed the discussion on whether the U.S. should export crude oil. A forty year old decree bans U.S. producers from exporting crude oil, and it needs to be repealed. It represents misguided protectionism and is a hangover from the days before the US embraced free trade. We think that exporting crude oil would be an economic benefit to the US, as it incentivises the full development of the US shale resource.
The 1973 Oil Embargo by several Arab Nations reduced oil imports into major consuming countries and caused oil prices to more than triple between 1972 and 1974. As a result, in 1975 a ban on crude oil exports was put in place by US Congress as one of the measures to reduce US exposure to global crude markets. Despite the measures, U.S. oil imports rose fivefold in the subsequent years to over 10 million(m) barrels(b)/day of crude oil today, making the U.S. the world’s largest oil importer.
Almost forty years after the oil export ban was enacted, the energy landscape has changed dramatically. In the last few years, US domestic oil production has increased to over 8m b/day, and is likely to exceed 11m b/day by the end of the decade, as a result of the development of shale oil. Oil imports have fallen sharply as a result of greater production of crude oil from the new shale plays and weaker US demand. This rapid turnaround has caused the price of US domestic light sweet crude oils (such as West Texas Intermediate, or WTI) to trade at a discount to international crude oils (such as Brent), and has raised the question of whether the U.S. should repeal the export ban and start exporting crude oil in order to defend domestic crude oil prices.
Despite importing nearly 8m b/day of oil, there is a strong case for exporting some of the rapidly growing light sweet crude oil supplies while continuing to import the medium crudes best suited for existing refineries.
There are many different types of crude oil. Broadly speaking, crude oil is often referred to as being ‘light’ or ‘heavy’ (depending on its density), as well as being ‘sweet’ or ‘sour’ (reflecting the level of sulphur it contains). The new crude oil being produced from the shale developments is entirely ‘light’ and ‘sweet’, similar in quality to Brent crude oil (a light sweet blend of crude oil traded in the North Sea), West Texas Intermediate (the light sweet oil traded at Cushing, Oklahoma) or Louisiana Light Sweet (LLS – the light sweet crude oil traded at the US Gulf Coast in Louisiana).
As the U.S. produces more light sweet crude oil, it needs to import less of that blend. At current growth rates, we project seeing domestic production of light sweet crude oil to exceed refinery demand at some point during 2014. As the U.S. is importing nearly 8m b/day of various crude oil blends, as required by the configuration of its refining capacity, the country has found itself oversupplied with light sweet crude oil, which is why we think the U.S. needs to start exporting.
Exporting crude could make a substantial difference to the future of the US energy market.
If crude oil is exported, WTI prices could potentially rise to meet global crude oil benchmarks. Additionally, the US oil industry would be better positioned to generate the cash flow needed to reinvest in oil production and develop the full potential of U.S. oil shale, which in turn could create new jobs.
We believe the U.S. ought to address this issue immediately. The WTI forward oil price in 2020 is only $77/barrel, ostensibly because the likely crude oil saturation in the country. At that price level, many of the non-core US oil shale plays would be marginal in economic terms and existing producers could not generate the necessary cash flow to reinvest and fully develop their acreage.
The US refining system is not set up to refine a higher volume of light sweet crude oil.
The US has the biggest refining capacity in the world. Like crude oils, every refinery is slightly different and has been constructed to handle a specific blend of crude oil. The US refining system has been upgraded significantly over the last decade to improve its ability to consume heavy and sour crude oil anticipated from Canada, Mexico and Venezuela. Many of these refiners are now making adjustments to their equipment to maximize their intake of the cheaper light, sweet WTI oil. However, many years and billions of dollars would be needed to make the wholesale changes required to consume the volume of light sweet oil that the US could produce. So, while the US refining system is running at full capacity and is exporting record levels of oil products to international markets, it is not configured to reap the maximum benefits of the shale boom.
If it is not refined or exported, US crude oil must either be consumed or stockpiled.
Quite simply, the excess light sweet crude will go into storage if it is not exported, refined or consumed. We expect some of the excess light oil volumes to be consumed as a result of refinery configuration changes (as much as 1m b/day over the next three years) or potentially exported in small quantities with one-off export licences, but these will be small in the context of increasing light sweet oil production from the US over the next few years. Ultimately, inventories of light sweet crude oil could start to build in 2015, even if growth in domestic demand slows the inventory build rate.
We believe that the export ban should be lifted.
Economic logic dictates that the ban should be lifted. However, political considerations will play a prominent role in this decision. In our opinion, the key point in this debate is that there is a closer correlation between US domestic gasoline prices and Brent oil prices than there is between US domestic gasoline prices and WTI oil prices. While US public opinion is that oil exports will cause higher gasoline prices, we believe that exporting as much as 1 million barrels a day of US crude oil into the global oil market of around 90 million barrels per day could temper Brent oil prices and therefore US gasoline prices.
Whether or not the ban is lifted, we expect to see a steady adjustment by the oil industry and lawmakers to relieve pressure in the system, until a time when it is politically palatable to lift the ban. Small scale one-off export approvals have started to occur, and we anticipate seeing more of them.
The issue is also gaining momentum in Congress, and the export ban could even be repealed by the President without Congressional approval, as long as it is deemed to be ‘in the national interest’.
The repeal of the export ban will be a hot topic in 2014, and we have high confidence that the correct action will be taken to ensure that the US fully develops its windfall of shale oil and that the US economy will benefit accordingly in terms of employment and balance of trade. When the market becomes satisfied that the issue has been resolved, we would expect WTI and LLS crude oil prices to reconnect with international crude oil prices. Resolving this issue and removing the uncertainty should greatly benefit the energy sector.
Tim Guinness, Will Riley & Jonathan Waghorn
Guinness Atkinson Global Energy Team
| Arguments to lift the crude oil export ban: | Arguments against lifting the ban: |
Exporting energy could benefit the US economy and show the USA’s commitment to free and fair trade.
It would have little effect on international oil prices and international product prices (i.e. gasoline and diesel).
Not exporting could cause lower WTI prices and weaker Exploration & Production profitability, thus putting oil industry jobs at risk.
Exporting would allow higher WTI oil prices which could facilitate higher reinvestment levels into shale production .
The US is already exporting some oil products, not to mention Liquid Natural Gas; why not crude oil? |
The broadly held view of the US public (incorrect in our opinion) is that gasoline prices will rise if the US exports its crude oil.
US consumers (i.e. US voters) are very sensitive about the price of gasoline and even a perceived negative change to the status quo could be politically damaging.
Job loss fears are usually raised over higher oil price concerns.
A lifting of the ban would be seen as favoring ‘Big Oil’ and could be viewed negatively.
Clean energy and climate activists are against shale oil production growth and would prefer that resources were directed to conservation and clean energy production instead. |