What’s attempted in this quarterly review is to look over the individual energy markets, from both a cursory fundamental and financial outlook and try to understand where each of these markets have been and are likely to go. From there, we can attempt to deliver some very generalized ideas on where some value might lie, both in the energy markets themselves and in the underlying equities that rely upon them. We won’t attempt to make specific recommendations or deliver target prices in this paper, instead hoping that it will open the door to further investigation towards specific stocks and futures trade ideas.
The most short term view of global crude oil would lend one to believe that prices are far overstretched: European recession, US slow growth patterns and a shocking drop in Chinese GDP growth projections have combined to drop demand of crude oil, or at least slow the growth of oil demand globally, all while the production of new supplies of crude have continued to advance largely due to new technologies in oil sands, deep water drilling and oil shale. This is no more evident than in the US, where the West Texas Intermediate benchmark for crude price has maintained a near $20 a barrel discount to the European (and mostly global) Brent North Sea price for most of the last two years.
But financial markets have outguessed the fundamentals, investing in crude oil through indexes, ETF’s and dedicated hedge funds, and moving crude oil most recently up $20/barrel on the mere threat of a loss of 3 million Iranian barrels and the increasing desire for commodity exposure as stock markets have risen. What has happened in the futures market has been a change from what was a very deep contango profile through much of the financial crisis to a now small premium profile, where front months are more expensive than back months – not in keeping with the likely improvement in economies that one should expect. However, just because markets are presently fundamentally ‘wrong’ is no reason to sell crude oil futures and hope for the best. Oil won’t bend to a simple analysis so quickly, that’s for sure.
And besides the likely recovery that will continue both here in the US and overseas, there are more fundamental reasons to believe that oil is relatively underpriced the further back in the curve you go – As global oil supplies become more tethered to government control as opposed to multinational E+P’s, the barriers to production growth continue to grow as well. There are new regulations, exploration constrained by social spending and shrinking public sector budgets, corruption, a distrust of multinationals who alone have the infrastructure to develop new oil sources and public courts looking to punish them at any opportunity. In this regard, Mexico and Brazil are two of the most obvious, if not singular, examples.
So where does this leave crude oil markets and their associated stocks? Well, there’s a lot to talk about there – and plenty of sectors inside crude oil that will react to these financial and fundamental inputs differently. Out of the many we could talk about - the big multinationals, the independent E+P’s, drillers and other service companies, state-run oil companies, energy transports, refiners – there has been an massive overweighting, and overpaying, for anything dividend-producing and a deeper value to be found in the more risky, but better priced, beta-rich stocks.
For a more specific breakdown of stocks and trade ideas, please read my weekly analysis, only on oilprice.com.
We know that non-renewable energy sources of any stripe are limited, but you’d never know it looking at natural gas prices over the last two years and particularly recently. It has been the history of unrestrained land-grabbing and leasing of shale assets in the Marcellus, Eagle Ford, Haynesville, Utica and a dozen more ‘plays’ that has glutted the market with gas and pushed storage well over 5-year averages and prices, at least for a time earlier this year, under $2/mcf.
This will not last. All commodities naturally have boom and bust cycles, and the cheapness of natural gas naturally puts economic pressure on conversion and a chase for more profitable production. All of this is happening right now in the natural gas market, but first we need to get through the drilling mania and subsequent monster surplus that the last 5 years has produced. There has been a massive trend from gas producers to move, as quickly as they can, away from “dry” gas and towards crude and natural gas liquids – but these changes are like turning a aircraft carrier around in a canal and have been taking several quarters. Add the voluntary “sequestering” of production begun by Chesapeake and the drop in drilling rig counts that we have seen and finally a drought in the Midwest that went a long way to burning off some of the surplus for air conditioning a burnt central US, and you’ve got storage numbers that are already quickly approaching 5-year averages again.
I am old enough to have been trading natural gas when it saw $7/mcf and $11/mcf and even $14/mcf in 2007 – and I have no doubts that we’ll see those numbers sometime again. It has been the nature of this beast to be incredibly volatile when it starts to move, even if it’s been nothing but the most quiescent lamb for the last two years at least.
All of which makes the independent natural gas stocks that underlie this market the most obvious value in all of energy.
Of course, timing a value play isn’t so easy – if you’re in a stock or a portfolio of stocks that underperform other indexes for months or even years, the prospect of a big move “somewhere down the road” is small consolation. In that regard, I have been recommending those independent natural gas production issues that pay you to wait in some way, whether with dividends or other distributions.
Coal, Nuclear, and Renewables
Time restricts any long analysis of these sectors, although they certainly deserve it. Coal in particular has taken it deeply on the chin; Alpha Natural Resources, for example, is the worst performing stock in the S+P 500 this year. I certainly don’t believe that coal as a major energy source is “finished”, either here in the US and definitely not in the emerging markets, but unlike natural gas, I also don’t see the upside in price either. While there will be value in coal stocks “somewhere”, I don’t think it’s here, not yet.
By. Dan Dicker of Oilprice.com