By Debbie Carlson
Underinvestment in oil and gas production will support commodity prices
The disconnect between the gains in energy stocks and the fall in crude oil prices suggests that something has to give. Energy market analysts say oil prices are more likely to rise than stocks to fall.
The S&P 500 Energy Sector SPDR ETF (XLE) is up 50% this year, representing the best performing sector in the S&P 500 Index. The top five holdings are Exxon Mobil (XOM), Chevron (CVX), Schlumberger (SLB), EOG Resources (EOG) and ConocoPhillips (COP).
Energy stocks hit a 2022 high in mid-November, even as WTI crude has steadily fallen 40% since June. Russia’s invasion of Ukraine triggered the oil rally in the first half of the year. Still, energy stocks have held up, as many hold production steady while reducing debt and buying back shares.
Crude oil prices fall
The weakness in crude oil stems from fears of a drop in Chinese demand as the country continues its zero-covid lockdown policy, says Stacey Morris, head of energy research at financial consultancy VettaFi. Market participants are also concerned about the impact of a slowing global economy on energy demand.
Focusing on the price of oil ignores the bigger picture of energy, Morris says. First-month natural gas futures prices are also down from this year’s highs, but are up 90% year-to-date. This is important because many energy companies will produce natural gas when they drill for crude oil.
The spread between crude oil prices and eventual products, known as distillate cracking spreads, remains high, says Jay Hatfield, CEO of InfraCap, an energy infrastructure investment firm. That’s why he thinks concerns about crude oil price weakness in the first month are overblown. He estimates that crude oil prices will range between $85 and $105 as the market heads into winter.
Energy stock prices rise
Stewart Glickman, deputy director of research at CFRA Research, says that while energy stocks are clearly outperforming commodities, the same has not been the case over the past three to five years.
“In a way, I think it’s a bit of a catch-up. Longer term, it’s actually not that far off the mark,” Glickman says.
While energy prices are off their peaks, the structural problem of supplying the commodity has not changed, which is a systematic underinvestment in crude oil, Glickman says.
The underinvestment will ultimately support longer-term energy stocks, says Bob Leininger, portfolio manager at Gabelli Funds, including the $2 billion Gabelli Equity Trust (GAB).
Looking at oil prices on the futures curve, most forward contract months are trading around $75-80 a barrel. These contracts did not experience the same price swings as the neighboring contract, suggesting stability and should reassure energy stock bulls. VettaFi’s Morris says US energy companies are still making a profit by pumping at these lower levels.
Investors can’t do bottom-of-the-envelope math to equate the price of crude oil to energy companies, says InfraCap’s Hatfield, especially so-called super majors such as Exxon Mobil and Chevron, which are diversified across several business sectors. .
“Everyone thinks there’s a simple equation [of] the price of oil multiplied by the volume equals the Chevron price,” he says.
How to differentiate energy actions
Charles Lemonides, founder of hedge fund ValueWorks, says investors shouldn’t necessarily think of oil stocks as a group, saying there has been a lot of variability in the stock price action.
While it owns Bakken-based fracker Chord Energy Corp (CHRD) and liquefied natural gas producer Cheniere Energy (LNG), ValueWorks has begun shorting Occidental Petroleum (OXY). Lemonides says the price is high because it was heavily bought by billionaire investor Warren Buffett and mutual fund firm Dodge & Cox.
CFRA Research’s Glickman has a “buy” view on Exxon Mobil and Permian Basin fracker Pioneer Natural Resources (PXD), and sees EOG Resources as a “strong buy.”
It is positive on Master LPs as they increase pipeline capacity, particularly to bolster natural gas capacity. Natural gas is often a by-product of oil drilling, and this energy must be stored and moved. Glickman says several pipeline companies are publicly discussing the value of building more gas-carrying capacity, which he says will likely be sent to the Gulf Coast.
“Then you can liquefy it, put it on a ship and send it to Europe, which is looking for anyone but Russia for gas,” he says.
CFRA has a strong buy rating on Targa Resources (TRGP) and a buy rating on Enterprise Product Partners (EPD).
Leininger says Gabelli owns Halliburton (HAL) and Schlumberger in the energy services company space as a play on the need for increased energy infrastructure over the next two decades.
Energy market watchers say commodity prices are likely to fluctuate in the coming months as long as Russia continues to dominate the news on the supply side.
“The bullish case for energy won’t go away until Europe’s energy crisis is resolved,” said InfraCap’s Hatfield.
(END) Dow Jones Newswire
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