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The Lay of the Land

By  Elliott H. Gue
Issue No.106 . Jun. 20, 2017

After OPEC and other major oil-producing countries agreed to curb production in fall 2016, specialist and generalist portfolio managers alike bet heavily on West Texas Intermediate (WTI) rallying to at least $60 per barrel this year.

This shot of confidence prompted investors to move down the quality chain in the search for value and alpha, with marginal equities rallying hard and high-yield energy bonds acting as though the 2014 collapse in oil prices was an aberration, never to be repeated.

However, in 2017, the story has shifted to how the surge in US oil output and stepped-up drilling and completion activity in prolific shale plays—abetted by upstream operators’ aggressive hedging when WTI fetched more than $50 per barrel—have threatened to overwhelm the extended OPEC and non-OPEC supply cuts.

Two weeks of disappointing data on US oil and refined-product inventories have reinforced the market’s negative sentiment toward WTI and energy stocks, while the International Energy Agency’s most recent forecast called for growth in non-OPEC output—led by the US—to offset projected growth in global demand next year.

A string of bullish inventory reports from the Energy Information Administration with larger-than-expected drawdowns in crude and refined-product inventories—a distinct possibility during the summer driving season, a period of strong demand—could catalyze a near-term pop in energy stocks and oil prices.

But ultimately the market will need to come to grips with a US onshore rig count that has increased by 425 drilling units since May 2016 and the Energy Information Administration’s (likely conservative) projections that domestic oil output will increase by an average of 340,000 barrels per day this year and 500,000 barrels per day in 2018.

At this point in the recovery, the US onshore rig count sits at levels (about 900) that Halliburton’s (NYSE: HAL) former CEO, Jeff Miller, last year asserted would have the equivalent productivity of about 2,000 drilling units at the previous cycle’s peak.

Barring further supply cuts from OPEC or security-related disruptions, oil prices could adjust to levels—potentially in the $30s per barrels—that would prompt the US shale complex to rein in drilling and completion activity.

A decline in the US onshore rig count would be the first sign of a US response, while a moderation in the pace at which the industry works off the inventory of drilled wells awaiting completion would also help.

Despite the near-term uncertainty and volatility in the energy sector, we can draw several firm conclusions from developments during the previous down-cycle and the recent up-cycle that will inform our investment strategy in the near term and long term.

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  • Upstream Strategy

    By Elliott H. Gue on Jun. 22, 2017

    Although our outlook for oil prices and the US energy patch favors an overweight position in core midstream holdings, nimble investors can generate alpha in upstream names by buying when oil prices retreat to the low end of their range and taking some profits off the table when they recover. Timing these moves is easier said than done. We highlight our favorite upstream stocks and dream prices to help instill discipline on the buyside.

  • Trends Favor Midstream

    By Roger S. Conrad on Jun. 20, 2017

    In this environment, we prefer midstream names that offer the best leverage to volumetric growth stories and have the balance sheet strength to pursue joint ventures with cash-strapped rivals. Not only do these MLPs pay generous yields that can improve your total return during periods of volatility, but the most recent down-cycle also prompted many midstream operators to take the necessary steps to put themselves on a more sustainable path by cutting their distributions and paying down debt. We highlight our favorites and dream prices for period of heightened volatility.

  • Upstream IPOs: Private Equity Cashes Out

    By Elliott H. Gue on May. 30, 2017

    Despite the underperformance of SPDR Oil & Gas Exploration & Production (NYSE: XOP) this year because of concerns about the outlook for energy prices and surging US production, several upstream operators have completed initial public offerings and more remain on the docket. Here are our takes.

  • Midstream IPOs: Rockin' the Bakken

    By Roger S. Conrad on May. 30, 2017

    The flow of initial public offerings in the midstream space has slowed significantly since investor demand for master limited partnerships peaked a few years ago. We review the latest MLPs to go public or file initial registration statements with the SEC.

  • Picking through a Bumper Crop of Oil-Field Service IPOs

    By Elliott H. Gue on May. 24, 2017

    The recent bumper crop of oil-field service IPOs includes a number of commoditized businesses seeking to strike while the iron is hot and a few niche plays that could be worth a look.

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    • Roger S. Conrad

      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor

    • Elliott H. Gue

      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor

    • Peter Staas

      Managing Editor: Capitalist Times and Energy & Income Advisor