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Dan Dicker

Dan Dicker

Dan Dicker is a 25 year veteran of the New York Mercantile Exchange where he traded crude oil, natural gas, unleaded gasoline and heating oil…

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These E&P’s Might Have Rallied To Fast Too Soon

In investing, there’s a patience factor that can’t be overstressed. We showed that kind of patience in the Spring of this year, as we loaded up on solid US independent E+P players like EOG Resources (EOG), Cimarex (XEC), Anadarko (APC), Hess (HES) and Continental (CLR) – all of which have paid fantastic dividends.

But there is a moment, even as we’re counting winners, where we have to find the right moments to add to winning positions and even cut back on them, waiting for another value moment. I believe we’ve reached such a moment now. As I look over the entire energy sector today, I find an increasing enthusiasm that is representing itself in oil stocks – an enthusiasm that was lacking when we originally bought stocks in April and May, but is telling me currently to wait – or even find other sub-sectors to focus on.

This week at the Asia-Pacific Petroleum conference, all but one of the 15 senior traders polled expected oil to remain between $40 and $60 for the next twelve months. They pointed out the increase in supply from Iran and Iraq as forces keeping prices low, but in my mind the most important point has been the very unexpected resilience of US independent oil producers to adjust to low prices. This has been the most surprising to me, as US producers have managed to continually retain financing in cash negative conditions for so long and even in many cases to produce oil while in bankruptcy.

The hopes for a production cut from OPEC and non-OPEC members later this month in Algiers is fading fast, with particularly the Iranians throwing cold water on the idea again earlier today. This is in keeping with the strategy of the Iranians, who only now are beginning to approach the export levels they had enjoyed pre-sanctions.

Indeed, both of these factors has me reassessing the likelihood of a full rebalancing of oil in the original timetable I laid out in my book more than a year and a half ago. While I have not moved in the slightest from my belief that oil prices are ultimately unsustainable below $75 a barrel and destined to move again well above $100 a barrel, the timing of this move now is likely to come later in 2017 than when I originally thought.

None of this has weighed heavily on oil stocks, however – particularly those with a focus on the white hot Permian basin. We’ve made some great profits on some of these, including Cimarex, and have been enjoying a big premium on the Mark Papa SPAC Silver Run Acquisitions (SRAQU), now invested completely in Permian producer Centennial Resource Development. But some of these have now run too far, too fast.

The most telling example is EOG Resources, an Eagle Ford shale specialist and one of the best, acquiring the private Permian producer Yates Petroleum for $2.5b. Immediately, despite a dilution of shares, a minimal cash outlay and a taking on of another $245m in debt, shares of EOG increased above $95. Yates, it should be remembered was operating at a significant negative cash flow during 2015 and 2016, unable to meet breakeven challenges of $40 oil. Yet because the acreage is in the super-hot Delaware basin, investors assume that EOG can apply the same efficiency magic to Yates’ Permian acreage as they did to their own EFS land.

Perhaps they can, but in no world is that expectation worthy of the kind of share bump that they have so far experienced. Normally, these kind of aggressive, forward-thinking acquisitions are at least met with the conservative and correct initial decline of shares.

We’ve benefited from this, but I am very skeptical of this rally.

I’ve recommended cutting back on some long-term investments in many of these names, including EOG, understanding that a fresh opportunity to buy them back at value may never reappear. That’s the choice we make in investing – and taking great profits while perhaps leaving a little on the table never made anyone poor.

Instead, I’ve recommended to subscribers to concentrate on natural gas stocks, which I believe hold better current value and, to a lesser extent, refiners – despite their current margin difficulties. We’ll center on some of those opportunities more fully in my next column.

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