Tuesday, January 5, 2021

Energy Industry Report

Energy 2020-4Q Review and Outlook

Michael Heim, CFA, Senior Research Analyst, Noble Capital Markets, Inc.

Refer to end of report for Analyst Certification & Disclosures

• Oil prices rose sharply beginning in November but are still well below levels at the start of the year. Oil prices continued to rebound from the sharp drop seen in the first quarter as investor enthusiasm about a Coronavirus vaccine pushed prices higher. WTI oil prices began the quarter in the mid thirties and finished the quarter near $47.50/BBL. Near-month oil futures prices are locked in a narrow range near current spot prices. Prices are still well below beginning-of-the-year prices near $60 per barrel.
• Natural gas prices had risen but have fallen in recent weeks due to warm weather. Natural Gas prices also rose during the quarter although they have slipped in recent weeks. Recent weakness reflects significantly warmer-than-normal weather. Population-weighted heating degree days were 21% warmer than the 10-year trailing average in the month of November and similar to historical averages in December. As a result of warm weather, natural gas in storage ended the year at all-time high levels for this time of year and 2.6% above the trailing five-year average.
• Energy stocks climbed 27% in the quarter mirroring the performance of oil prices. Energy stocks, as measured by the XLE Energy Index, rose alongside oil prices climbing 27% during the quarter. The rise began in November when oil prices rose. Even with the strong performance in the fourth quarter, however, the energy index was down 38% in 2020. This compares to a 14% rise in the overall market.
• The near-term outlook for energy stocks has improved but we still have long-term concerns. The rebound in oil prices came faster than expected. We have been adjusting our models to reflect higher prices but are maintaining our long-term oil price forecast of $50 per barrel and $2.50 per mcf. Our near-term outlook for energy stocks has improved. We expect companies to report favorable results for the next few quarters unless rising production pushes energy prices lower. Longer-term, we have concern that oil demand will be constrained by power generation competition from renewable energy and decreased demand for gasoline and diesel due to a growth in electric vehicles. At the same time, supply pressure from an increasingly active OPEC and continued drilling productivity will mean lower energy prices.

Oil Prices

Oil prices continued to rebound from the sharp drop seen in the first quarter as investor enthusiasm about a Coronavirus vaccine pushed prices higher. WTI prices began the quarter in the mid thirties and finished the quarter near $47.50/BBL. Near-month oil futures prices are locked in a narrow range near current spot prices. Prices are still well below beginning-of-the-year prices near $60 per barrel. Interestingly, drilling had not resumed by the end of the year. Baker Hughes reported 351 active rigs in the United States as of December 31, less than half the number from a year ago. Consequently, domestic production has not changed. The U.S. Energy Information Administration (EIA) reports that domestic oil production rose a modest 2.7% between September and November (the last month available) and attributes the increase largely to hurricane-disrupted wells coming back online. We would expect to see production expand in upcoming months with increased drilling.

Natural Gas Prices 

Natural Gas prices also rose during the quarter although they have slipped in recent weeks. Recent weakness reflects significantly warmer-than-normal weather. Population-weighted heating degree days were 21% warmer than the 10-year trailing average in the month of November and similar to historical averages in December. As a result of warm weather, natural gas in storage ended the year at all-time high levels for this time of year and 2.6% above the trailing five-year average. Natural gas futures prices show prices rising modestly as the futures curve extends into the spring.

Energy Stocks 

Energy stocks, as measured by the XLE Energy Index, rose alongside oil prices climbing 27% during the quarter. The chart below shows that the strength in energy stocks began in November, the exact time that oil prices began to rise. The performance in the quarter far outpaced the overall market. Even with the strong performance in the fourth quarter, however, the energy index was down 38% in 2020. This compares to a 14% rise in the overall market.

Outlook 

The rebound in oil prices came faster than expected. We have been adjusting our models to reflect higher prices but are maintaining our long-term oil price forecast of $50 per barrel and $2.50 per mcf. Energy companies should start reporting positive cash flow at these prices and increasing drilling budgets. That said, marginal wells will most likely not be drilled, and production growth will be difficult unless we see prices rise back to a level near $60/bbl. and $3.00/mcf.  Companies must continue to work to lower costs to adjust to current prices by finetuning drilling techniques. 

Our near-term outlook for energy stocks has improved. We expect companies to report favorable results for the next few quarters unless rising production pushes energy prices lower. Longer-term, we have concern that oil demand will be constrained by power generation competition from renewable energy and decreased demand for gasoline and diesel due to a growth in electric vehicles. At the same time, supply pressure from an increasingly active OPEC and continued drilling productivity will mean lower energy prices. We recommend investors stay focused on energy companies with solid balance sheets, low operating costs and protected prices.

 

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ANALYST CREDENTIALS, PROFESSIONAL DESIGNATIONS, AND EXPERIENCE

Senior Equity Analyst focusing on energy and utility stocks. 24 years of experience as an analyst. Chartered Financial Analyst©. MBA from Washington University in St. Louis and BA in Economics from Carleton College in Minnesota. Named WSJ ‘Best on the Street’ Analyst four times. Named Forbes/StarMine’s “Best Brokerage Analyst” three times. FINRA licenses 7, 63, 86, 87.

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RESEARCH ANALYST CERTIFICATION

Independence Of View

All views expressed in this report accurately reflect my personal views about the subject securities or issuers.

Receipt of Compensation

No part of my compensation was, is, or will be directly or indirectly related to any specific recommendations or views expressed in the public appearance and/or research report.

Ownership and Material Conflicts of Interest

Neither I nor anybody in my household has a financial interest in the securities of the subject company or any other company mentioned in this report.

NOBLE RATINGS DEFINITIONS	% OF SECURITIES COVERED	% IB CLIENTS
Outperform: potential return is >15% above the current price	78%	34%
Market Perform: potential return is -15% to 15% of the current price	5%	1%
Underperform: potential return is >15% below the current price	0%	0%

NOTE: On August 20, 2018, Noble Capital Markets, Inc. changed the terminology of its ratings (as shown above) from “Buy” to “Outperform”, from “Hold” to “Market Perform” and from “Sell” to “Underperform.” The percentage relationships, as compared to current price (definitions), have remained the same.

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Report ID: 11924