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  • Roger S. Conrad


Another Chance to Buy Top Quality Energy Cheap

Benchmark North American oil prices are back over $70 per barrel. That’s a level few outside of our Energy and Income Advisor investment community expected at the beginning of 2021. Natural gas, meanwhile, has pushed to its highest price since December 2018, well over $4 per million British Thermal Units.

Energy stocks, however, remain largely unloved. In fact, the S&P Energy Index is still 11 percent below its late June high, before the combination of profit-taking, concerns about a new coronavirus wave and OPEC+ output increases took the wind out of its sails.

Energy stocks’ underperformance of the commodities demonstrates once again the lack of investor conviction in the staying power of the sector rally that began in early November 2020. In fact, the S&P Energy Index currently trades almost 20 percent lower than it did in early January 2020 prior to pandemic, when benchmark oil sold for $10 a barrel less than it does now and gas was almost $2 lower.

Mid-Year Commodity Outlook

Energy was the top-performing sector in the S&P 500 in the first half of 2021 jumping 45.61%, nearly triple the S&P 500’s 15.24% gain over a similar holding period.

That represents the S&P 500 Energy Index’s best showing relative to the S&P 500 in the first half of the year since at least 1989 when the former index was created. 

Indeed, energy has smashed all records so far in 2021 for performance relative to the S&P 500, the only comparable example was the group’s 28.51 percentage point outperformance relative to the S&P 500 in the 6 months ended February 2005, during energy (and oil’s) last big commodity super cycle.

Energy Gets a Win in Court

Rumors of an Iran nuclear deal dominated energy headlines this week. That’s hardly surprising. Nor is the selling it spurred of oil and energy stocks. But as we’ve pointed out, even if that country’s oil does return to world markets, it would have little real impact on the global supply and demand balance–especially at a time when US shale producers are staying conservative and post-pandemic demand is surging.

That’s why the more important news by far for US energy investors was a ruling by a federal judge in Louisiana, which blocked the Biden Administration’s “pause” on issuing new oil and gas drilling leases on federal lands.

Bringing Back the Buyers

So far in 2021, oil and gas stocks are far and away the stock market’s top- performing sector. In fact, capital gains alone for the S&P Energy Sector Index and Alerian MLP Index are more than four times the total return on the S&P 500.

Like the previous two, this issue of Energy and Income Advisor focuses on energy companies’ Q1 results and guidance updates. And what we saw is very much a potential driver for more gains this year in the best in class energy stocks we’ve been recommending.

Not only are companies reporting continuing improvement in industry fundamentals. But their numbers—particularly solid dividend coverage and rising levels of free cash flow after distributions—demonstrate management has adapted business plans and financial strategies to the current stage of the energy cycle.

Energy Earnings: Few Surprises But Good Ones

Last year, energy investors faced a perfect storm. Demand for refined products collapsed in the face of measures to contain an historic pandemic, at the same time producers abruptly began to prioritize free cash flow over output.

The result was a business meltdown for all but a handful of best in class companies. And even they were forced to dramatically shift strategy, as plunging share prices and pressured credit ratings all but cut them off from capital markets on reasonable terms.

This year is shaping up as a far different animal. Even sector leaders like Portfolio members Enterprise Products Partners (NYSE: EPD), Pioneer Natural Resources (NYSE: PXD) and Schlumberger Ltd (NYSE: SLB) still haven’t made it back to pre-pandemic levels. But we have seen some very impressive gains across the board off the late October 2020 lows. And that price momentum has accelerated so far in 2021.

Energy Earnings Approaching: Clues to the Cycle

By Q4 2021, total utilization of the largest oil pipelines in the Permian Basin will drop to 57 percent. That’s according to a recent survey from industry research firm Wood MacKenzie.

Some level of spare capacity is necessary for a functioning midstream system, to accommodate demand spikes and the fact that pipelines and related infrastructure must be periodically sidelined for maintenance. The current level, however, is quite elevated, basically for two reasons.

First, based on announced plans of producers for this year, US crude oil output is expected to drop well below the pre-pandemic level of 13 million or so barrels per day. Second, a sizeable amount of new shipping capacity came on line at the end of the previous decade to accommodate expected increases in shale output. That includes natural gas pipelines built to ship associated natural gas produced from oil wells, much of which historically has been flared.

Energy Bull Market: Positioning for the Next Phase

The nearly five-month long rally in energy stocks has taken a well-earned pause.

After racing to a nearly 90 percent return since Halloween 2020, the diversified S&P 500 Energy Sector Index has backed off a little less than 7 percent from the 52-week high. The midstream focused Alerian MLP Index has given back about 5 percent of its nearly 60 percent jump. And the S&P Oil & Gas Exploration Index is off about 6 percent after a more than 120 percent leap.

Despite their gains the past few months, many energy stocks up and down the value chain still trade in a lower range than they did the last time crude oil held above $50 a barrel, or natural gas was at $2 per million British Thermal Units for an extended period. And share prices are well below levels typical of the last time we saw $60 oil or $2.50 gas.

Worst to First: What’s Next for Energy’s Hot Stocks

After lagging the field the past few years, energy stocks have torn up the track so far in 2021. The S&P 500 Energy Sector Index is up more than 40 percent year to date, and almost 90 percent since results of the November presidential election became clear.

All of our Portfolio and High Yield Energy producers and midstream stocks are up strongly as well. ONEOK Inc (NYSE: OKE) is 90 percent higher since early November. Crestwood Equity Partners (NYSE: CEQP) has nearly doubled and Occidental Petroleum (NYSE: OXY) has more than tripled, to highlight just a few rags to riches stories.

Natural Gas Shows its Value

Plunging temperatures this winter are doing in Texas what scorching weather did in California this summer. That’s mainly proving natural gas is absolutely indispensable to America’s energy needs, and most probably will be for decades to come. In California last summer, prices for electricity spiked and blackouts loomed as the state’s solar-heavy power grid was unable to handle the demand surge. In this Texas’ winter, the combination of unprepared infrastructure, a nuclear plant shutdown, frozen wind power facilities and massive demand for natural gas heating triggered basically the same thing.

Energy Stocks: Bullish on Dividends

The vast majority of energy companies have yet to report Q4 earnings and to update investors on guidance. Most have, however, now declared their dividends for winter quarter 2021. And encouragingly, all that have so far have elected to either maintain or increase payouts.

To be sure, the number of energy companies growing dividends is still small, especially relative to a few years ago. We continue to expect more of the best in class companies and MLPs to follow Enterprise Products Partners’ (NYSE: EPD) lead in returning to a policy of regular increases. But given concerns about the economy and the sector’s inability to raise capital on reasonable terms, managements will likely stay conservative with their cash this year.

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  • Live Chat with

    Elliott and Roger on Jul. 29, 2021

  • Portfolios & Ratings

    • Model Portfolios

      Balanced portfolios of energy stocks for aggressive and conservative investors.

    • Producers and Drillers

      Our take on more than 50 energy-related equities, from upstream to downstream and everything in between.

    • MLPs and Midstream

      Our assessment of every energy-related master limited partnership.

    • International Coverage

      Roger Conrad’s coverage of more than 70 dividend-paying energy names.


    • Elliott H. Gue

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

    • Roger S. Conrad

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