Heading into 2018, we like the setup for US-levered oil-field service stocks, though investors will need to remain selective and avoid the problem spots and value traps that lurk in this industry.
What’s changed over the intervening months?
Our outlook for oil prices is certainly more bullish than in late 2016 and early 2017, when we warned that the US production response would surprise to the upside and offset OPEC’s production cuts.
Although oil prices have rallied on several occasions over the past three years, we (rightly) regarded these upswings as ephemeral because the oil market remained in contango—that is, longer-dated futures commanded a premium to near-term contracts. This environment encourages market participants to store oil for future delivery and makes it easier for producers to hedge expected output.
In addition to improving investors sentiment, the recent strength in crude-oil prices should support solid capital spending among US exploration and production companies, many of which have taken advantage of the rally in WTI to lock higher prices on expected production.
Nevertheless, sentiment toward the industry remains cool, with investors erring on the side of caution and viewing the group as a show-me story—one of the big reasons oil-field service stocks hadn’t participated in the rally in crude-oil prices until recently. At these levels, the downside risk in many oil-field service names appears limited in the event that our investment thesis doesn’t work out.
Today, crude oil is in the early innings of a cyclical recovery. The market for Brent oil (an international benchmark) entered backwardation earlier this year, with front-month futures trading at a premium of $2.89 per barrel to volumes slated for delivery 12 months later. This structure discourages market participants from paying to store oil and indicates a tightening supply-demand balance.
We explore what the Nebraska Public Service Commission's approval of the Keystone XL pipeline's cross-border segment really means for TransCanada Corp.
Massive distribution cuts from the likes of Plains All-American Pipeline LP have severely damaged midstream master limited partnerships' (MLP) reputation among income investors. But our favorite MLPs trade at favorable valuations and offer exposure to compelling volumetric growth stories.
The divergent performance between Noble Midstream Partners LP and Hess Midstream Partners LP since their initial public offerings demonstrates what investors value in an environment where energy prices remain lower for longer.
Break-even rates continue to fall across the board in US shale plays, but the efficiency gains that come from exploiting multiple oil-bearing formations with the same infrastructure give the Permian Basin an edge in the battle for market share.
Over the past 12 months, the difference between the top and bottom performers in the Alerian MLP Infrastructure Index amounted to about 60 percentage points. Capturing this upside requires on-the-ground intelligence, which is why we attend the MLPA Association's annual investor conference every year.
The tale of two cycles looks set to continue for another year. Drilling activity may have bottomed in the international markets, but pricing pressure will persist until price deflation improves break-evens and upstream operators have more confidence in the outlook for oil prices. Meanwhile, some US exploration and production companies may moderate their spending increases relative to last year, but this short-cycle market remains the best bet for incremental growth and pricing gains in 2018--especially if our call for oil prices to average between $55 and $60 per barrel pans out. Given our preference for US exposure at this point in the cycle, we review the challenges, opportunities and market dynamics in three prominent onshore service lines through the lens of companies’ third-quarter results: contract drilling, pressure pumping and proppant.
The recent pullback in midstream master limited partnerships creates buying opportunities. We've also added a power company to our Focus List and the International Portfolio.
Does Canada's midstream segment provide a model for the evolution of US master limited partnerships? We explore what factors have helped Canadian pipeline stocks outperform despite currency headwinds and lower realizations on oil and gas prices.
We have increased our exposure to exploration and production companies in recent months, focusing on names with solid balance sheets and franchise assets that legitimately could live within cash flow. Third-quarter results from these companies were a mixed bag, though their stocks have rallied.
Big changes are afoot in the midstream segment. Many master limited partnerships appear to have taken Enterprise Products Partners LP's lead and shifted their focus to building distribution coverage and reducing equity. We explore which names will be able to make this transition with relative ease and which names face more of a slog to put themselves on a path to sustainability.
Elliott and Roger on Nov. 30, 2017
Balanced portfolios of energy stocks for aggressive and conservative investors.
Our take on more than 50 energy-related equities, from upstream to downstream and everything in between.
Our assessment of every energy-related master limited partnership.
Roger Conrad’s coverage of more than 70 dividend-paying energy names.