In the short term, oil prices appear to near the top of their range, having rallied too far, too fast off their February low. At these levels, US shale producers will start to ramp up drilling and completion activity and hedge their expected output for 2017, though decline rates could accelerate in the back half of the year.
Despite the sharp drop in oil prices last year and the recent recovery, rebalancing the market will take time; years will pass before oil prices top $60 per barrel for an extended period. As a result of over-exuberant investors piling into the sector in recent weeks, many energy stocks have rallied to valuations that have outstripped reasonable expectations for fundamentals, setting the stage for a pullback.
We remain bullish on exploration and production companies with franchise assets, low production costs, strong balance sheets and high-quality management teams; these names stand to take market share in an environment where energy prices struggle to break out of their trading range.
Thanks to efficiency gains and price concessions on basic services, America’s best independent exploration and production companies can generate a solid return on investment in their core acreage even if oil prices range between $40 and $60 per barrel in coming years.
To identify the best-positioned producers, we considered a handful of basic criteria. First, we focused on companies that can reduce their capital expenditures and live within (or close to) their annual cash flow without suffering a major decline in production.
Companies that fit this bill won’t need to borrow significant sums or issue a ton of equity to fund their planned expenditures for 2016 and can continue to grow their output. These names will benefit disproportionately when oil prices rally to the high end of our range and hold up better and take market share when the commodity slips to the lower end of our forecast.
Overall equity issued by energy-focused master limited partnerships (MLP) declined by 58 percent last year; we expect this trend to continue in 2016.
Our near-term outlook for crude-oil and natural-gas prices hasn't changed, though investors should consider taking profits on demand-oriented names that tend to thrive when oil prices dive.
The severe downdraft in the prices of crude oil, natural gas and natural gas liquids has pressured producers’ cash flow and outpaced reductions to service costs and capital expenditures. Accordingly, the cash flow shortfalls that predominated in the salad years have continued in the lean years, setting the stage for further spending cuts in 2016.
Data from the Commodity Futures Trading Commission indicates that hedge funds and other institutional investors have shorted the equivalent of 160 million barrels of West Texas Intermediate via futures contracts.
The Master Limited Partnership (MLP) Association hosted its annual investor conference in Orlando last week and, as always, the Energy & Income Advisor team was on the ground to talk to management teams and fellow investors. Here are some of our bigger-picture takeaways from the event.
After plunging almost 50 percent from early May 2015 to mid-February 2016, the Alerian MLP Index has defied the critics and torched slow-to-react short sellers by surging 45 percent since its nadir. But the easy money has been made: Investors must now focus on which names are best-positioned to grow in an environment where energy prices remain lower for longer.
Activity levels and pricing for oil-field services and equipment will likely remain under pressure in the US onshore market this year, with early 2017 bringing a bit of a recovery on both scores. But a return to the levels witnessed during the boom years appears unlikely, especially if Saudi Arabia opts to tap some of its spare capacity to take market share and keep oil prices in check.
Too many pundits talk about a potential recovery in oil prices without considering the drivers and implications.
The utility sector's implosion in 2002 and 2003 has some important lessons for MLP investors.
Elliott and Roger on Jun. 30, 2016
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