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The Outlook for the oil patch. Or, wanna’ buy a house in North Dakota?

Sigma Investment Counselors

February 20, 2015

A combination of softened global demand and increased marginal production — principally in North America — has precipitated the collapse in crude oil prices over the past six months.  An analyst being interviewed on CNBC today suggested that oil prices would rebound sometime in 2016.

It was also disclosed yesterday that Warren Buffet’s Berkshire Hathaway recently disposed of a portion of its holdings in oil companies.  It seems unlikely that this move would have been taken if Buffet expected oil prices to recover soon. However, this is a guess.

What we do know about the long-term price outlook for any “finite supply” commodity is that over time, the price will rise unless demand falls in line with the decline in supply (following the economic principle of supply and demand).

The lessons learned over the past four decades from dependence upon unstable countries, which provided a significant share of crude oil to global markets, and additionally, actions to promote green energy by the environmental movement in many countries around the world, would suggest that it is unlikely that carbon-based fuel conservation measures will wane any time soon.

We also know the enterprises that have the most debt-supporting operations, and which have the highest costs of energy production, will go out of business, and that supply will go “offline.”

This could take many, many months, or potentially years.  Hence, investment exposure to only those energy companies, with fortress like balance sheets, is warranted.

Equally important for investors to consider is not only the direct impact on the energy companies by the crude collapse, but also those ancillary businesses that are affected both positively and negatively by the changing dynamics. For example, a residential real estate investment trust, which had cast its fortunes collecting properties in North Dakota, is probably going to face significant challenges.

My colleague, Walter Kirchberger, CFA®, has commented in past blogs about the relative unattractiveness in the near-term for automobile producers which rely heavily on alternative fuels for motility of vehicles (Tesla).

When all is said and done, trying to time sectors is as difficult as trying to jump in and out of stocks, generally speaking.  The best process is maintaining a diversified portfolio, and perhaps putting on small tilts when a sector appears under or overvalued.

All comments or questions are welcomed.

Bob Bilkie, CFA®

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