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Energy stocks ‘look extremely attractive’ right now, strategist says

Hennessy Energy Funds at Hennessy Funds Portfolio Manager Ben Cook joins Yahoo Finance Live to discuss commodity prices, investor positioning, the looming fuel shortage, and the outlook for the global economy.

Video Transcript

- Energy stocks remain the uncontested winners in the S&P 500 this year. This despite a more than 25% pullback in underlying oil prices since June. Our next guest says investors will be rewarded with a return of around 20% of the sector's current market cap on average. That's over the next three years. Hennessy Energy Transition Fund portfolio manager Ben Cook joins us now to discuss this group generally. So let's talk about here your bull theses and why you think we're going to continue to see outperformance after what has already been a pretty remarkable run for these stocks. What's the main reason that people should be owning these shares?

BEN COOK: Yeah. Good morning. Thanks for the question. Yeah. We have a favorable view of the traditional hydrocarbon energy sector for a couple of reasons. Look, commodity prices remain buoyant despite some of the headwinds that were mentioned in a previous segment. We foresee growth in crude oil demand this year as well as growth in natural gas demand on a global basis this year and next. And high commodity prices are affording many of the companies in the US upstream sector with tremendous cash flow. And that cash flow is allowing these companies to pay down debt and, obviously, repurchase shares, as we've seen from Occidental and other companies.

When you consider the fact that many of these companies screen very attractively on a valuation basis, given the embedded commodity price deck in their current equity value, as well as investor positioning, which in our view remains below historical averages, we think there's a good reason to believe that further commodity price strength into the fourth quarter into next year and of course continued good financial results from these companies will support outperformance at least for the next 12 to 15 months.

- Hey, Ben. In your notes to us, you said that energy equities are actually returning significant levels of cash to investors. What does that look like relative to the rest of some of the equities markets players that investors can look across?

BEN COOK: Yeah. No, that's a great question. We look at the major sector categories in the S&P 500. And energy at this point in time screens attractively not only on a valuation basis, but on a free cash flow yield basis. So on average, that energy sector is-- S&P 500 energy index is yielding about 11% on a free cash yield basis. And this compares very favorably to the remainder of the broader market. Broader market is in the single digit range. So the energy stocks, again, to us from an investor return perspective look extremely attractive.

- All right. So we got these companies returning cash to shareholders, but not necessarily spending that on exploration and production. I'm wondering what you think of the global supply picture here. We have OPEC Plus, which has lowered its production targets. But already before that I think OPEC Plus was 2 and 1/2 million barrels per day in deficit. So where are the extra barrels going to come from if a lot of these players are not incentivized to find new oil?

BEN COOK: That's a great question. I think the primary driver, the bullish narrative behind crude oil prices today is really several fold. You've got inventories on a global basis well below historical seasonal norms. You have OPEC that is, as you point out, is under producing their targeted quota production levels. To us, that suggests that they are at or near maximum capacity. So very little cushion should the need arise for additional barrels.

Again, financial discipline here in the United States by the upstream sector means that more cash is going to investors as opposed to the industry for development and drilling to support future production growth. Those are all key reasons. Interestingly, on a short-term basis, we have withdrawals from the SPR which will cease in October, and then further embargoes on Russian crude exports into the eurozone in December, and then products embargoes that will be implemented in February.

So demand risks have been well covered by the market. I think they're priced into the commodity price at this point. But supply risks remain a significant driver of commodity price strength in our view. And for that reason, we think oil prices will rise into the fourth quarter and into next year.

- Ben, the most visible measure of the oil price, of course, that consumers watch is the gasoline price. And there we have, of course, seen declining prices pretty steadily along with the oil price. I just saw this morning GasBuddy saying 1 in 10 US gas stations is now selling for $2.97 a gallon or less. Unfortunately, my local one is about-- well, not quite $1 higher than that. But still. So what you're saying also seems to imply that gasoline prices are going to go up from here.

BEN COOK: Yeah. I think to an extent. We've enjoyed a pullback in gasoline prices. Obviously, there was some demand curtailment at $5 a gallon. Retail gas prices we're now on a national average basis around $3.70 per gallon. On a seasonal basis, we've made it through the summer driving season, which is an important demand period for gasoline. And, fortunately, knock on wood, we've avoided hurricane activity in the Gulf of Mexico that historically has been a driver of disruption and higher gasoline prices.

But look, if you believe that crude oil prices on a global basis will rise into the fourth quarter with the demand drivers and the important supply risk that we just talked about, then, yes, gasoline prices more than likely will begin to rise into the fourth quarter and we see strength in the next year.

- Hennessy Energy Transition Fund portfolio manager Ben Cook. Thanks so much for joining us here today and breaking the entire sector activity down for us. We appreciate it.