Tuesday, July 2, 2019
Energy Industry Report
The Storage Numbers Tell it All
Mark Heim, CFA, Senior Research Analyst, Noble Capital Markets, Inc.
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- Energy stocks had a rough quarter in response to falling energy prices. The XLE Energy Select SPDR Index fell 5.1% during the quarter in response to a 5.4% decline in oil prices and a 14.0% decline in natural gas prices.
- The decline in oil prices reflect rising inventories. Oil inventories are up 4.6% year over year. Oil prices seem to have shrugged off Middle East tension. The spread between Brent (global) prices and WTI (domestic) widened in response to increased domestic production.
- Natural gas prices also reflect rising inventories. Gas in storage rose after a mild April and May causing a drop in prices in June. Storage has returned to historical levels after being below average. As we enter the quiet summer period, we would not expect to see a significant natural gas price appreciation until the fall at the earliest.
- Energy future prices do not offer much hope. Future oil prices are below current oil prices making it difficult for companies to lock in prices in order to support future drilling. Without a significant rise in prices later in the year, realized prices will most likely drop in 2020 for most energy companies. We believe investors should be cautious regarding energy stocks until signs of a turnaround.
Energy Commentary – Second Quarter 2019
It was a difficult quarter for energy stocks as prices fell in response to falling energy prices. Energy stocks, as measured by the XLE Energy Select Sector SPDR Fund, fell 5.1% over the three months ended June 30, 2019. The decline stands in contrast to a 2.6% increase in the S&P 500 Composite Index over the same time period. Both oil and natural gas prices declined during the most recent quarter. Oil prices, as measured by the WTI August 2019 future price, declined 5.4% from $61.81 per barrel to $58.47 per barrel. Natural gas prices, as measured by Henry Hub August 2019 futures, declined even more significantly, falling 14.0% from $2.68 per thousand cubic feet to $2.308.
The decline in oil prices corresponds to rising inventories with the EIA reporting consolidated oil stocks of approximately 2 million BBLS (as of 6/21), up 4.6% from a year ago. Oil imports continue to decline even as the export of petroleum products grows. Domestic production of oil continues to grow. The spread between North Sea Brent oil prices and WTI oil price has widened from $5.23 per barrel to $8.04 per barrel in response to increased domestic production. The oil futures curve is relatively flat with prices rising towards $60 over the next few months but then falling to $57 next summer and $55 the year thereafter. We believe the decline reflects a belief that near-term prices are artificially inflated by political tension in the Mideast and perhaps a feeling that long-term global expansion may be getting old in the tooth.
The decline in natural gas prices, on the other hand, is due to domestic issues. The EIA reports natural gas storage of 2.3 trillion cubic feet (as of June 21, 2019), up 11.4% from the same time last year. After several months of being near five-year lows, storage levels have returned to historical averages. The rise in storage has been most pronounced in the Midwest where weather was abnormally mild in April and May. At the same time, domestic gas production has continued to grow, at least until reported for April. It should be noted that natural gas prices began their sharp decline in May and June. We suspect domestic production in May and June will show a decline when reported in response to lower prices.
The current outlook for the energy sector is somewhat negative. The euphoria of merger activity in previous quarters has dissipated. We have noticed an increase of bankruptcy filings among marginal energy companies this quarter. The rise in international oil prices due to political unrest seems destined to be short-lived. Other energy future prices are low. Storage levels are high. Undoubtedly, companies will respond to low prices by cutting back drilling, which will reduce production and the storage glut. Until companies begin reporting such cutbacks, we would encourage investors to be cautious regarding the energy sector.
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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. Professor at St. Louis University’s MBA program. 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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Report ID: 10978