Arnold Van Den Berg: Bullish on Oil and Gas

The fund manager believes the industry has more upside than the short-term estimates suggest

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Sep 25, 2017
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“It is our opinion that the consensus view finds comfort in groupthink and therefore pays little attention, if any, to the historical accuracy of the agencies publishing these estimates.” Â -Arnold Van Den Berg

Why is Arnold Van Den Berg (Trades, Portfolio) optimistic about the price of oil, and the future of companies in the industry, when much of the market is not?

He became a contrarian after studying the forecasts—and followups—by two major energy monitoring agencies. He believes their initial estimates, and the market’s consensus, reflect too much dependence on short-term thinking and groupthink.

Who is Van Den Berg?

A Holocaust survivor, Van Den Berg received a securities license in 1968 and began selling mutual funds. During the six years he sold funds, the market was suffering its worst times since the 1930s.

Those tough years prompted Van Den Berg to study many aspects of investing; one of the most influential findings was that managers using a value strategy protected their clients more effectively and delivered more consistent returns. That, in turn, led him to Benjamin Graham and the science of security analysis.

With the wisdom he gathered from Graham, Van Den Berg decided to start his own investment management business, putting the Graham philosophy at its core.

In 1974, Van Den Berg founded Century Management, which started by offering separate accounts. One of those accounts was an all-cap value strategy, while the other was a conventional balanced strategy. It won its first institutional account in 2001. Two years later it set up a mutual fund family called CM Advisors Family of Funds.

In his writing and commentaries, Van Den Berg is often joined by two other members of the senior management team, James Brilliant and Scott Van Den Berg.

He has been widely praised for his investing knowledge and skills. In 2014, he was included in Magnus Angenfelt’s book, “The World’s 99 Greatest Investors.”

Van Den Berg and the oil and gas sector

Investors looking for value, for stocks at a deep discount to their intrinsic value, have few choices after almost a decade-long bull market. One of those few choices is the energy sector, where the prices of oil and gas stocks have been depressed since the price of oil collapsed in 2014.

Lots of opportunities, but many investors are concerned the sector may be a value trap rather than a value opportunity. Van Den Berg disagrees.

In the commentaries section of the Century Management website, he and his team focus much of their attention on the sector, and they have analyzed why it does not get the respect it deserves.

In “The Long-Term Price of Oil Hangs on the Short-Term Focus of Consensus,” Van Den Berg and his team posit three factors that suggest energy stocks and the price of oil will go up sooner than many market observers believe:

  • The demand for oil is more robust than the estimates suggest.
  • Shale production will not meet the production targets expected of it.
  • The global inventory of oil is going down.

Regarding the demand for oil, they argue energy market traders and investors are short-term focused, giving most of their attention to short-term supply, demand and inventory estimates. Those estimates come from the International Energy Agency (IEA) and the U.S. Energy Information Administration (EIA).

The authors say the consensus view is caught up in groupthink and does not pay enough heed to the historical accuracy of these agencies. By comparing initial estimates with their follow-up revisions, the authors say these agency estimates tend to be revised higher. Given the revised numbers are more recent and accurate, they think these provide a more realistic picture of the underlying fundamentals.

As to real demand, they point out annual demand has grown by 1.3 million barrels per day since 2008 and is expected to hit 1.5 million barrels per day this year and 1.4 million barrels per day in 2018.

Turning to shale production, Van Den Berg argues the biggest driver of energy industry pessimism is the view shale productivity will continue to increase, dumping increasing volumes onto the market. He and his team argue investors cannot trust the modelling done by the EIA, saying its production forecasts often exceed actual industry production.

On the inventory issue, the Century Management team believes the EIA numbers, on which the consensus view is based, are misleading. They write, "This production optimism [the EIA's] is based on a belief that you can flip a switch, ramp up production and increase well productivity. We will see in Chart 3 that this presumption is not unfolding as the consensus camp expects." (bolding by the authors; Chart 3 is not included with this article but is available in the source document.) Without that increased production, inventory levels will not increase on a straight-line basis, nor will there be any compounding effect.

To buttress their last point, the authors provide this Bloomberg chart, which summarizes the oil inventory surplus in the OECD (the Organisation for Economic Co-operation and Development) countries over the past year:

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Finally, after their analysis, the authors say they would prefer investors and analysts adopt “a more reasonable” approach to assessing supply and demand, rather than continuing to focus on misleading weekly estimates. Should oil prices more accurately reflect industry economics, it would be a healthier environment for consumers, producers and the economy. Still, they expect oil prices to move higher, regardless of what happens in ongoing assessments.

Looking at the investing side, almost 29% of the CM Advisors Fund, the firm’s biggest fund, is listed in the energy sector, in keeping with its non-pessimistic view of the industry. The biggest holdings in the fund are all connected to the energy industry in some way:

These are sizeable holdings in a $38.5 billion fund.

Conclusion

As a true value investor, Van Den Berg is focused on an area which the rest of the market is pessimistic.

The research he and his team have done asks whether that pessimistic outlook is grounded in facts. By looking at the initial estimates and subsequent revisions by the energy agencies, he has found cause for optimism and investment.

And as a follower of Benjamin Graham, he has found an opportunity to buy stocks at a discount because he knows something the broader market does not.

Disclosure: I do not own shares or units in any of the securities listed in this article, and do not expect to buy any in the next 72 hours.