With Oil Prices Down and Demand Slowing, Are Energy Stocks a Good Play?

Crude oil prices are down and demand is slowing, but BlackRock's Koesterich makes the case that energy company stocks remain attractive

Crude oil prices fell in July and early August, according to an August 12 report from the International Energy Agency, reporting that "weak OECD refinery runs in June offset concerns about escalating conflicts in Iraq, Libya and Ukraine."

The IEA has lowered its global oil demand growth forecast for 2014, based on "lower-than-expected 2Q14 deliveries and a weaker GDP outlook from the IMF," though it expects demand growth to "accelerate" in 2015 as "the economy improves," and thus has raised it "baseline demand estimate for the year.

In a recent blog post by Russ Koesterich, the chief investment strategist of BlackRock argues that oil supply is likely to remain controlled, but that oil demand will continue to grow. So what does this mean for energy investing? According to Kosesterich, sticking with energy stocks even if oil prices don’t rise is probably a good idea.

“In short, oil prices still matter. And depending on the trajectory of events in the Middle East, this may come to matter quite a bit,” according to his most recent Market Perspectives blog.

Kosesterich writes. “Currently, oil prices remain in a somewhat precarious balance, supported by a long-term rise in North American production, but at the mercy of falling production and exports in much of the Middle East and Africa.”

Koesterich writes that oil prices are still a major player because energy is still a key commodity in manufacturing. It accounts for a large part of household spending, and still has a major impact on fiscal positions — especially in countries where oil is subsidized.

Oil demand will continue to grow despite constrained supply. “Oil prices remain elevated because global demand has continued to climb, despite slower growth in China, and supply overall has been unexpectedly constrained by both geology and geopolitical unrest,” he writes.

Koesterich also says that investors should “maintain an overweight exposure to energy stocks” based purely on attractive valuations; energy sector valuations still have room to grow when measured against the S&P Global 1200 ndexes, he says.

“As you would expect, there is also some evidence that rising oil prices hurt consumer-related stocks—higher energy effectively crowding out other discretionary spending—but the relationship is not particularly strong,” Koesterich said.

Koesterich also makes no assumptions when it comes to predicting the outcome of events that occur in the Middle East, but he does say that the knowledge that we have on the limited oil supply shouldn’t be a shock. There are also good opportunities in certain integrated companies and exploration and production companies where there is resource growth or restructuring potential, he concludes.

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