A number of managers and commentators have recently suggested that BP and Shell are on depressed valuations that justify investors buying into them. However, Sutton says that the companies are struggling to increase their reserves, meaning in the medium-term they are in for some trouble.
“We have a very disciplined approach to growth, so we need companies to show some capacity to grow and replace depleting resources, which has kept us out of the very large companies for the last few years,” he said.
The £1bn JPM Natural Resources fund, managed by Neil Gregson and his team, invests in mining and minerals, gold and energy, and currently has roughly one third in the energy bucket. It holds 44 per cent in diversified minerals and mining and just 13.5 per cent in gold.
Like all funds focused on these areas, it has struggled over the past three years, losing 49.61 per cent as those sectors sold off.
“We obviously prefer energy to gold, but from a bottom-up perspective, energy is challenging,” Sutton said.
This was highlighted by poor and unexpected recent results from both Shell and BG Group, which had a dramatic effect on their share prices.
Shell issued a fourth quarter profit warning on 17 January, saying that figures would be significantly below market estimates. Shares fell 4 per cent on the news and are still down.
Performance of stocks vs index over 3 months
Source: FE Analytics
BG Group, which JPM Natural Resources owns, reported last week that production would be lower than expected from its core assets in Egypt. Shares dived on the news and are still down 14 per cent.
Sutton says that the fund held BG Group because of its success in developing new reserves in Brazil, but that the company’s base production figures were where the problem was.
Shell, on the other hand, has more longer term problems, he says, along with BP.
“They are almost a victim of their own success: it’s difficult to replace their legacy assets,” he said.
“Growth in oil and gas seems to be harder to come by and if you want to access that growth you need to go further down the market cap scale, because larger companies are struggling to grow.”
Sutton says that there are good opportunities in Kurdistan and Colombia in particular for companies to find new reserves.
In Kurdistan, many private investors have looked to access the potential of the reserves there through Gulf Keystone Petroleum, but the JPM fund does not, chiefly because of “corporate governance risk”.
The company has been beset by controversy over commitments made to shareholders, including M&G’s Tom Dobell, and compensation of executives.
Artemis’ John Dodd was one specialist oil and gas manager to warn FE Trustnet readers off the stock last year.
Sutton used to own it, but found a company in the same area without these issues.
“It had a good run and we didn’t need to take the corporate governance risk. We could get that through DNO, one of our top-10 holdings,” he said.
DNO is listed on the Oslo stock exchange, and its shares have risen 94.05 per cent over the past year as Gulf Keystone Petroleum has lost 24.42 per cent.
Performance of stock vs index over 1yr
Source: FE Analytics
Sutton explains that the company had a very successful drilling result in November in the Tawki field in Kurdistan, which has helped push shares higher.
He and the team also favour Amerisur Resources, which drills in Colombia and Paraguay. The company is listed on the London Stock Exchange, on AIM, and has proved volatile over the last year. Over three years, however, it has made more than 130 per cent while the FTSE has risen 25.98 per cent.
Performance of stock vs index over 3yrs
Source: FE Analytics
The fund has held the company for two years, catching most of the upswing in share price, and it has had persistent upgrades to reserves over that period. Sutton says this is still not reflected in the share price.
One larger company the fund does hold is Anadarko, listed on the New York Stock Exchange.
“It’s another reasonably large energy company that does have production growth, which is being driven by North American shale production,” Sutton said.
The team has also bought into two uranium producers: Fission Uranium and Alpha Minerals. The market was priced as if uranium would never be used again, Sutton added.
“We felt people had become overly bearish on the uranium price post-Fukushima,” he said.
“Few analysts focused on two companies that made big discoveries in Canada.”
Jupiter’s Steve Davies, manager of the Jupiter UK Growth and Jupiter Undervalued Assets funds, agrees that large cap oil and gas stocks are ones to avoid.
However, he argues that there is the real risk of a lower oil price, which could harm this sector as a whole.
“It’s interesting that last year you had a lot of geopolitical disruption in the oil market with Iran and Libya and south Sudan and a huge amount of oil production taken out and yet the oil price didn’t go up at all,” he said.
“So we think, who knows how the sanctions process with Iran might go, but if there’s any hint of good news coming out of that you could see an oil price $10 to $15 lower than we’re at at the moment.”
“This would be very bullish for the market as a whole and global growth, but obviously not for the big oil producers whose cashflows would look very weak under those circumstances.”
The manager says BP and Shell will be the biggest losers from these circumstances.
JPM Natural Resources has ongoing charges of 1.68 per cent and requires a minimum initial investment of £1,000.
