Image Credit: It’s Our City (Flickr)

Monitoring the Gusher of Cross Currents in the Energy Industry

A plan from the White House to allow drilling in the Gulf of Mexico. Calls for a crude export ban. A Biden tweet asks companies running gas stations to drop prices. A proposed price cap on Russian oil. And OPEC-plus output is expected to remain steady. These are just some of the events impacting energy company stocks. Meanwhile, travel in the U.S. skyrocketed to levels not seen in years to kick off the summer vacation season. For their part, oil industry stocks, as measured by the XLE, are down 25% from their high a month ago (June 8), and are approaching their 200-day moving average. Is the cooling off in oil company stocks temporary? Could the recent sell-off attract dip buyers, and what is the overall health of the industry beyond the outside noise? 

Source: Koyfin

Selling Gulf Drilling Leases

On July 1, in a disappointment to some environmental groups, the Biden administration made two moves to open public lands to fossil fuel extraction. The administration held its first onshore lease sales, and it released a proposal for offshore drilling that could open parts of the Gulf of Mexico and Alaska’s Cook Inlet to leasing through 2028.

Oil industry officials said the action would do little to help counter high energy prices. This is important to the President as gasoline prices have been a daily reminder for voters of how life has changed since the President has taken office. Biden’s taking action against higher fuel prices could be seen as a political move aimed at helping the mid-term elections come out in favor of the President’s party. The oil industry officials throw cold water on any thinking that it would change prices, they say there will be a months-long gap before a new plan can be put in place. The oil industry spokespersons say the delay could cause problems in planning new drilling and potentially lead to decreased oil production. Overall, oil companies are hesitant to go all out and bid for leases and commit extraordinary resources to projects when the administration’s commitment is uncertain.

The administration had already suspended lease sales earlier in 2022, citing climate concerns. As a result of a court order by a U.S. district judge in Louisiana, the company involved was cleared to resume.

There is a long start-up time between the bidding process and the developing drilling operations. In the meantime, there is no sign for the oil companies to feel comfortable committing to long-range projects because the administration has not shown unwavering commitment. Resources allocated to what the administration says it is committed to, that is a move away from fossil fuels, would seem more appropriate in the long run for energy companies.

Export Ban Feasibility

The Biden administration wants to potentially place an outright ban on U.S. exports of oil and refined products. Speaking to reporters during a tour of the Strategic Petroleum Reserve in Louisiana, Energy Secretary Jennifer Granholm said that the administration was “not taking any tools off the table” in its effort to reduce prices at the pump, including reimposing the 1970s ban on oil exports that was lifted in 2015. This is confusing to consumers and oil companies alike as it was just last December that Granholm said an export ban was not under consideration. Secretary Granholm’s comments seem to mark a significant shift in energy policy for the administration.

A ban would have to take into account the complex global oil market. Each country does not produce the quality of crude oil or refined petroleum products used in its country. For many, imports from the U.S. have no substitutes. This would force them to find other providers, or do without. The highly advanced U.S. refining capabilities allow it to take low-cost heavy oil from Central America and Canada and turn it into high-grade gasoline. This ability to input low-cost crude and export high-value refined products is a net positive for the U.S. when measuring trade surplus’/deficits.

While an export ban may score points politically, it may not accomplish a useful goal. In January, the Dallas Federal Reserve released a study on the potential impacts of a crude oil export ban. It measures possible consequences on worldwide energy prices and their impact on Americans. The study concluded that a halt of U.S. exports “would lower the supply of oil in global markets and raise its price” and “one would expect global fuel prices, if anything, to increase as a result.”

Image: A tweet from @POTUS draws a snarky reply from the domestic oil and gas advocate USOGA.

OPEC-Plus Output Decision

OPEC+ is the name given to the combined oil-producing countries that include the 13 members of OPEC, and 10 other oil-producing countries including Russia. On Thursday (June 30) OPEC+ confirmed it would not increase output for the month of August any more than previously announced. The group had concerns about oversupplying in the face of mounting factors that could lead to a recession. Ironically, one of those factors is the tight global supply of oil.

Previously, OPEC+ decided to increase output each month by 648,000 barrels per day (BPD) in July and August. The OPEC+ group of producers ended the meeting by agreeing to stick to its output strategy. The producers did not discuss policy for September or beyond.

Analysts Report

“Energy industry fundamentals remain strong.” Wrote Noble Capital Markets, Senior Energy Analyst Michael
Heim, in his quarterly
report on the industry released this week. Heim went on to write that cash flow levels are envious in the industry, and debt levels are being pared down. He maintains his positive bias toward the sector and favors small-caps within the sector “with the ability to expand operations.”

 
Take Away

Energy companies’ performance, particularly those involved in oil or natural gas, have had excellent performance over the past two years – they have been the top-performing sector so far this year. However there has been a bit of a dip, and there are many crosscurrents that could make a continued rise a bit choppier than it had been.

The outlook on the industry is positive as the companies are faced with an enviable number of options and opportunities to rework their finances and perhaps move into new projects, both traditional and future-looking.

They, however, need to pin down the administration on whether it is committed to their products long term. This nod to the future could open the door to more investment in production. Alternatively, if they are caught in political positioning that may not carry any weight six months down the road, wrong decisions now could be expensive.

Read Michael Heim’s Energy Industry Report – The Outlook for Energy Stocks Remains Favorable
here.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://insideclimatenews.org/news/01072022/public-lands-fossil-fuel-drilling-leases-biden/

https://www.whitehouse.gov/briefing-room/statements-releases/2021/01/27/fact-sheet-president-biden-takes-executive-actions-to-tackle-the-climate-crisis-at-home-and-abroad-create-jobs-and-restore-scientific-integrity-across-federal-government/

https://www.npr.org/2022/07/02/1109552068/a-biden-administration-offshore-drilling-proposal-would-allow-up-to-11-sales

https://www.forbes.com/sites/daneberhart/2022/06/07/banning-us-exports-would-be-bidens-ultimate-energy-folly/

https://www.thehindu.com/news/international/opec-plus-the-cartel-and-its-allies-that-keep-oil-on-the-boil/article65493511.ece#:~:text=OPEC%20Plus%20refers%20to%20a,%2C%20Azerbaijan%2C%20Bahrain%2C%20Brunei%2C

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Tuesday, July 5, 2022

Energy Industry Report

The outlook for energy stocks remains favorable

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

Refer to end of report for Analyst Certification & Disclosures

• Energy stocks finally cooled off after five consecutive quarters of gains. The energy stock index declined 6.4% in the June quarter due to weakness in the overall market. The S&P Composite Index declined 16.4% during the quarter.
• Oil prices continued the climb begun in the spring of 2020 rising 5.5% in the quarter. The climb may have come to an end, however, with WTI prices peaking at $120 per barrel in the first week of June before settling at current levels near $108 per barrel. Supply concerns associated with the Ukraine conflict have been replaced by worries that economic tightening will lead to a slowdown in the world economy. OPEC announced production increases right at the end of the quarter, further putting pressure on prices. Active rigs have almost tripled in the last two years but remain below pre-pandemic levels and are only one-third of peak levels in 2015.
• Like oil prices, natural gas prices were strong in April and May but fell sharply in June. For the quarter, spot gas prices declined 3.9%. Gas in storage remains near the bottom of historical levels as the industry begins to refill storage fields
• Energy industry fundamentals remain strong. The recent drop in oil and gas prices does not concern us as prices are still well above the levels assumed in our financial and valuation models. Companies able to expand drilling efforts are doing so at a very high return on equity. Cash flow generation is high, and companies are facing the envious situation of trying to decide what to do with the cash. We maintain our positive bias on the group and favor small cap energy stocks with the ability to expand operations.

Energy Stocks

Energy stocks, as measured by the XLE Energy Index, finally cooled off after five consecutive quarters of gains. The XLE declined 6.4% in the June quarter. The decline was largely due to weakness in the overall market as oil and natural gas prices were largely unchanged. The S&P Composite Index declined 16.4% during the quarter. Looking at the XLE performance, it is interesting to note that the index’s performance was up sharply until hitting a peak on June 8^th and then declining 15% in the last three weeks of the quarter.

Oil Prices

Oil prices continued the climb begun in the spring of 2020. The climb may have come to an end with WTI prices peaking at $120 per barrel in the first week of June before settling at current levels near $108 per barrel. Supply concerns associated with the Ukraine conflict have been replaced by worries that economic tightening will lead to a slowdown in the world economy. OPEC announced production increases right at the end of the quarter, further putting pressure on prices. The gap between Brent and WTI pricing has grown with Brent oil prices now commanding a $7/bbl. premium. Oil future prices are currently backward declining a few dollars each month and falling below $100 by yearend. Drillers are beginning to react to higher oil prices, but the response has been slow. Active rigs have almost tripled in the last two years but remain below pre-pandemic levels and are only one-third of peak levels in 2015. As the chart below shows, there has been a disconnect between the oil rig count and oil prices in recent years that has become only more exaggerated in recent months with oil prices rising above $100.

Figure #1

Source: Baker-Hughes

Natural Gas Prices

Like oil prices, natural gas prices were strong in April and May but fell sharply in June. For the quarter, spot gas prices declined 3.9%. Gas in storage remains near the bottom of historical levels as the industry begins to refill storage fields. Gas storage is about 300 billion cubic feet or 12% below the trailing five-year average. This will most likely keep natural gas prices at elevated levels until the injections season ends in November.

Figure #2

Outlook

Energy industry fundamentals remain strong. The recent drop in oil and gas prices does not concern us as prices are still well above the levels assumed in our financial and valuation models. Companies able to expand drilling efforts are doing so at a very high return on equity. Cash flow generation is high, and companies are facing the envious situation of trying to decide what to do with the cash. Debt levels have been pared down and managements are reluctant to initiate/raise above in case the industry goes into a down cycle forcing them to reverse course. Share repurchase remains a viable option especially if energy stocks continue to be weak alongside the overall market. We maintain our positive bias on the group and favor small cap energy stocks with the ability to expand operations.

GENERAL DISCLAIMERS

All statements or opinions contained herein that include the words “we”, “us”, or “our” are solely the responsibility of Noble Capital Markets, Inc. (“Noble”) and do not necessarily reflect statements or opinions expressed by any person or party affiliated with the company mentioned in this report. Any opinions expressed herein are subject to change without notice. All information provided herein is based on public and non-public information believed to be accurate and reliable, but is not necessarily complete and cannot be guaranteed. No judgment is hereby expressed or should be implied as to the suitability of any security described herein for any specific investor or any specific investment portfolio. The decision to undertake any investment regarding the security mentioned herein should be made by each reader of this publication based on its own appraisal of the implications and risks of such decision.

This publication is intended for information purposes only and shall not constitute an offer to buy/sell or the solicitation of an offer to buy/sell any security mentioned in this report, nor shall there be any sale of the security herein in any state or domicile in which said offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state or domicile. This publication and all information, comments, statements or opinions contained or expressed herein are applicable only as of the date of this publication and subject to change without prior notice. Past performance is not indicative of future results.

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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

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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: 24648