Is this energy subindustry on the mend?

Why oil exploration and production has started to recover.

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"Oil exploration and production (E&P) has started to recover from its darkest days in March and April, and I think companies in this subindustry have the best opportunity in energy to deliver improved profit margins, returns, and capital discipline in the coming years," says Nathan Strik, portfolio manager of Fidelity® Select Natural Resources Portfolio (FNARX).

As of May 31, Strik says, he finds the valuation of E&P companies to be attractive, and he's significantly overweight this segment.

Strik believes demand for energy has begun to recover from "an incredibly depressed level." The International Energy Agency (IEA) expects global demand in 2020 to fall by more than 9 million barrels per day. In comparison, global demand fell by about 3 million barrels a day during the global financial crisis of 2008–09.

A sharp recovery to prior levels for oil prices is unlikely, Strik warns, adding that it make take 2 or more years for demand to recover to pre-COVID-19 levels. Also, he notes large inventories will need to be reduced over time.

"However, improvement from the incredibly stressed levels in March and April appears likely and seems to be underway," he says.

Strik says his focus remains on companies he thinks can grow production at a reasonable rate while generating free cash flow and improving returns on capital. Fund holdings as of May 31 that fit these criteria, he says, included Diamondback Energy (FANG), Pioneer Natural Resources (PXD), Noble Energy (NBL), Parsley Energy (PE), and Magnolia Oil & Gas (MGY).

Fidelity® Select Natural Resources Portfolio held securities mentioned in this article on May 31, 2020. As of this date, these companies accounted for the following percentages of fund assets: Diamondback Energy, 1.44%; Pioneer Natural Resources, 3.35%; Noble Energy, 2.75%; Parsley Energy, 1.95%; and Magnolia Oil & Gas, 1.77%.

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