Two Top Picks In Energy This Year

The New Year is a time for a fresh start, which will be welcomed by energy investors. The sector did better last year than it has in the recent past, but still underperformed the broader market. The problem is that U.S. oil production continues to increase, threatening the recovery in prices that we saw in the second half of last year. We have already heard from the Trump administration that they will be conducting a massive lease sale on both the Pacific and Atlantic coasts this year which is good for the long-term prospects of oil companies, but does not bode particularly well for the price of oil in the medium term. That doesn't mean, however, that there will not be opportunities in energy stocks in 2018, so let's look at a couple of them.

As I have said many times in the past, making predictions for extended time periods is, at best, extremely difficult. There are enough known variables that can throw off even the most researched and thought out idea, let alone the unpredictable events that often change the outlook in a fundamental way. That said though, picking stocks for the next year or so is in some ways a bit easier. Twelve months is a long enough period for fundamental factors to outweigh the vicissitudes of the market, yet not long enough to factor in massive, existential changes. The trick for stock-picking in that time frame is to first decide on some trends that you expect to see over the next twelve months, then to extrapolate actionable ideas from that analysis.

From a general economic perspective, it is hard to see anything but blue skies ahead. If you put politics aside and look objectively at data, even those opposed to Trump have to admit that growth is not just continuing, but accelerating, and that that is being reflected in stock prices. You could say that it has nothing to do with who is in the Oval Office, but it is nonetheless a fact. That overall growth will help to offset the negative effects on WTI of high production to some extent, and will probably push money into underperforming sectors such as energy. That is why, even though prices look a bit vulnerable, there are still stocks to buy.

As for the trends in energy stocks this year, the most powerful could well be a shift back into oilfield service companies. Trump's big lease sale ensures that E&P companies will have plenty of opportunities, and the much lower corporate tax rate in the U.S. will allow them to take advantage. In other words, we will not have to see higher oil prices right now to justify a recovery in capital expenditure by oil companies, and the big firms in oilfield services will benefit.  Schlumberger (SLB) has used the industry's dip as an opportunity to acquire capacity and increase their domination, so they stand to benefit the most and look like a must own for 2018.

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The other tend that I am expecting in 2018 is a bit less obvious, and therefore a bit riskier.

Natural gas had another terrible year in 2017, and with U.S. oil, and therefore nat gas production set to continue rising, the case for any company in the business seems on the surface hard to make. To make it you have to look a little deeper, and there are a couple of things that make me believe that we will see some recovery this year.

Firstly, as with oil, general economic growth and increased demand will offset those production increases, and the shift in the U.S. towards natural gas over dirtier fossil fuel power sources continues apace. In addition, at some point the long-awaited effects of exports of liquified natural gas (LNG) will kick in.

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The kind of price disparity shown above cannot last as the market becomes more globalized, so it is quite possible that U.S. natural gas prices will rise, even if supply levels remain high. If they do, it will benefit all oil companies, but to play it best you need to look at a company heavily dependent on gas, such as Chesapeake Energy (CHK).

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As you can easily see from the chart above, CHK has had its problems this year, but they are currently profitable and have worked to reduce their debt burden, so are placed to take advantage if prices do recover.

2018 will be an interesting year in energy, but then pretty much every year is these days, as the long-term shift to alternatives battles with rapidly increasing energy demand. Last year's themes were an oil price recovery, a drop in capex spending and falling natural gas prices. All markets have a tendency over time to revert to the mean, so a reversal in all those themes, at least on a relative basis, looks likely.  That is why, going into the New Year, SLB and CHK are my picks, but I am a trader so, as always, I reserve the right to change my mind!