Market Sector Update
- Volatility rocked the oil markets as crude oil prices fell 67% in the quarter and a perfect storm of falling demand and
increased supply jolted the industry. The “OPEC+” group of producing countries was unable to reach an agreement on
production cuts, which led to a price war that increased oil production. This happened at the worst time because of the
unprecedented demand shock from the spread of the coronavirus.
- OPEC+ failed to agree to extend output cuts beyond March 2020 due to Russia’s decision to disagree with the rest
of the producers. This led Saudi Arabia to start a price war with a significant increase in production rather than by
restricting production. At the same time, worldwide oil demand fell by more than 20 million barrels a day due the
spread of COVID-19 as the world sheltered in place, schools closed and nonessential businesses shut down. The
demand shock was most notable in lower usage of gasoline and aviation fuel.
- Current market conditions are leading oil and gas companies to reduce capital spending, suspend share repurchases
and cut dividends. Rig count is down in the U.S. and oil inventories are rapidly filling up around the world. As the price
of oil approaches a cash cost, forced production shut ins for some oil producers will occur. This will affect production
in U.S. shales and older conventional oilfields.
- The Portfolio had a negative return for the quarter, underperforming the S&P 1500 Energy Sector Index, its
benchmark. The index also experienced negative performance over the period.
- During the quarter, we raised cash as oil fundamentally deteriorated due to the OPEC and Russia price conflict and
demand destruction related to the COVID-19 pandemic. We reduced our exposure to oil service companies and
exploration and production companies.
- Key detractors to the Portfolio’s relative performance included holdings in Chevron Corp., Exxon Mobil Corp., WPX
Energy, Inc., PBF Energy, Inc. and Continental Resources, Inc.
- Industry allocations changed when compared to those of the prior quarter. Approximately 25% of the equity holdings
in the Portfolio were allocated to the oil and gas exploration and production industry segment, followed by 18% to oil
and gas equipment and services and 17% to oil and gas refining and marketing.
- The Portfolio’s allocation to U.S. equity also was steady from the prior quarter at about 19% of equity assets and cash.
- The focus of the energy strategy remains on investing in companies that can create value over the full course of the
energy cycle. We identify those as companies that are low-cost operators, have strong balance sheets, have the ability
to grow profitably and have strong return on capital.
- We believe the oil markets will be well over supplied in the second and third quarters of calendar year 2020 due to
lower demand associated with the COVID-19 pandemic. Markets should start to rebalance in fourth quarter 2020 as
demand returns and oil production will be lower due to forced shuts and production cuts. We think natural gas will
remain over supplied in 2020 and will start to rebalance as fundamentals improve due to lower associated gas coming from lower U.S. shales oil production.
- It is impossible to have oil demand down 25+% without affecting the oil supply. Oil production in the U.S. will be
forced to shut in and we think production could be down more than 2 million barrels a day by the end of calendar year
2021. We think that Saudi Arabia, Russia and other OPEC countries will end their price war and cut production to slow
the building of worldwide oil inventories. We believe the oil markets will begin to rebalance when production shuts in
and economic activity begins to normalize in the second half of calendar year 2020.
- The demand shock is very negative as some onshore oil prices go into the red as infrastructure, pipelines and storage
fill to capacity. There is very limited spare capacity left in the world to store crude and products and we could test the
limits of inventory capacity in the next three months. We expect oil inventories to reach full capacity and force oil prices
to cash cost. Both will force shut ins before oil demand begins to return as the world gets back to a working life.
The opinions expressed are those of the Portfolio’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through
March 31, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is
not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives,
financial needs, risk tolerance and time horizon. Past performance is not a guarantee of future results.
Top 10 equity holdings as a percent of net assets (%) as of 03/31/2020: Phillips 66 5.4, Valero Energy Corp. 5.2, Concho Resources, Inc. 5.0, Pioneer Natural Resources Co. 4.8, Dril-Quip, Inc. 4.1, Marathon Petroleum
Corp. 4.0, Wright Express Corp. 3.9, Hess Corp. 3.6, Aspen Technology Inc. 3.4, and Baker Hughes, Inc. 3.3.
The S&P 1500 Energy Sector Index is an unmanaged index comprised of securities that represent the energy sector of the stock market. It is not possible to invest directly in an index.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets
in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises
caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined
Risk factors: The value of the Portfolio’s shares will change, and you could lose money on your investment. Because the Portfolio invests more than 25% of its total assets in the energy related industry,
the Portfolio may be more susceptible to a single economic, regulatory, or technological occurrence than a portfolio that does not concentrate its investments in this industry. Investing in companies involved in one
specified sector may be more risky and volatile than an investment with greater diversification. The Portfolio typically holds a limited number of stocks (generally 35 to 55). As a result, the appreciation or depreciation
of any one security held by the Portfolio may have a greater impact on the Portfolio’s net asset value (NAV) than it would if the Portfolio invested in a larger number of securities. Investing in the energy sector can be
riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments, and the cost assumed by energy
companies in complying with environmental safety regulations. The Portfolio may invest in Initial Public Offerings (IPOs), which can have a significant positive impact on the Portfolio’s performance that may not be
replicated in the future. These and other risks are more fully described in the Portfolio’s prospectus.
Annuities are long-term financial products designed for retirement purposes. Annuity and life insurance guarantees are based on the financial strength and claims-paying ability of the issuing insurance company. The
guarantees have no bearing on the performance of a variable investment option. Variable investment options are subject to market risk, including loss of principal. There are charges and expenses associated with
annuities and variable life insurance products, including mortality and expense risk charges, management fees, administrative fees, expenses for optional riders and deferred sales charges for early withdrawals.
Withdrawals before age 59 1/2 may be subject to a 10% IRS tax penalty and surrender charges may apply.