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  • Roger S. Conrad

Issues

The Summer of Growth

There’s no doubt it’s been a disappointing summer for energy stocks.

Energy stocks were the best-performing group in the S&P 500 from the March 23rd lows through the June 8th peak, soaring 96.5%. However, from June 8th through the present date, energy reversed course, falling about 22.9% compared to a return of just under 9% in the S&P 500.

And that’s despite the fact that oil prices have continued a steady drift higher all summer from around $38 in early June to approximately $43 today while natural gas prices have climbed steadily from a June 25th low under $1.50/MMBtu to above $2.60/MMBtu.

Resilience and Green Shoots

Natural gas never managed to break $2 per thousand cubic foot and oil prices actually went negative. So Q2 results for energy companies were never going to be pretty. And with Covid-19 uncertainty still a threat up and down the value chain, it’s little surprise second half 2020 guidance has remained cautious.

Nonetheless, we’re seeing unmistakable signs of resilience, as well as the green shoots of recovery. And both are good reasons to buy best in class energy stocks, which continue to offer their most attractive yields in memory.

One of the green shoots is what appears to be the first monthly rise in North American hydraulic fracturing activity in months, with the final count returning to levels not seen since April. July activity has been particularly robust in the Permian Basin. But there are some signs of improvement elsewhere also, including the Anadarko (Oklahoma), Bakken, Eagle Ford (Texas) and Niobrara (Colorado) regions.

Energy’s Best are Often its Biggest

This week, frac sand MLP-turned-C-Corp Hi-Crush Inc (OTC: HCRSQ) opened a new chapter in its long slide, filing for Chapter 11 bankruptcy.

It’s been literally years since this company was an Energy and Income Advisor recommendation—or since we’ve rated shares anything but a strong sell. But Hi-Crush’s now total demise does offer us several key lessons, as we build positions in best in class companies to capitalize on an energy sector recovery.

First, this bankruptcy is yet another demonstration that C-Corp conversions of MLPs are no antidote to financial and operating pressures.

This Pullback is Bullish for Strong Companies

Since the previous issue of Energy and Income Advisor, energy stocks have backed off a bit more from their June 8 recovery high. The S&P 500 Energy Sector Index finished last week down -21 percent from that level, though it’s still 60.7 percent above the March 18 low.

Super majors-focused NYSE Arca Oil Index (NYSE: XOI) has given back -20.4 percent and is now up 71.6 percent from mid-March. And the midstream-heavy JP Morgan Alerian MLP Index ETN (NYSE: AMJ) has retreated -23 percent to a point 113.2 percent above the recent bottom.

Pullbacks like this one come with the territory when a market has risen as far and fast as energy stocks have since March. If it does extend, we’ll consider it an improved opportunity to buy best in class companies at better prices, with an eye on our Dream Buy levels.

Dumping the Weak, Adding to the Strong

The rally in energy stocks from mid-March has taken a breather. On June 8, the S&P 500 Energy Sector Index reached its highest point since early February, up 97 percent from its March 18 low. A few days later, it was down more than 17 percent.

Other indexes have followed the same pattern. Super majors-focused NYSE Arca Oil Index (NYSE: XOI) returned better than 105 percent from mid-March to June 8, only to give back roughly 17 percent. And the midstream-heavy JP Morgan Alerian MLP Index ETN (NYSE: AMJ) retreated 16 percent, after running higher by 152 percent.

Quality is Still King in the Energy World

Energy stocks have rallied hard in the month of May. The S&P 500 Energy Sector Index is now up more than 70 percent from its March 18 low. The super majors-focused NYSE Arca Oil Index (NYSE: XOI) is higher by 82 percent plus. And the midstream-heavy JP Morgan Alerian MLP Index ETN (NYSE: AMJ) is now better by 140 percent.

None of these indexes is as yet anywhere close to where it started the year. The S&P Energy Index is 60 percent under its all-time high in mid-2014, the last time oil sold for more than $100 a barrel.

True, benchmark WTI Cushing crude will run you about one-third of that now. The same is true for natural gas at Henry Hub, and prices are lower still at hubs in Appalachia and Canada. Unlike oil, gas has not rebounded appreciably from the March low.

Q1 Earnings and Guidance: Here’s What’s Critical

The prospect of deep cuts in production has sparked a bounce in oil prices. And at least for the moment, crude is trading over $20 a barrel again across North America, with global benchmark Brent in the upper 20s.

The real action, however, has been in energy stocks, which have literally vaulted from last to first in terms of S&P 500 sector performance. The S&P 500 Energy Sector Index is more than 50 above its March 18 low. The super majors-focused NYSE Arca Oil Index (NYSE: XOI) is up 55 percent plus. And the midstream-heavy JP Morgan Alerian MLP Index ETN’s (NYSE: AMJ) has exploded upward more than 80 percent.

None of these indexes are close to erasing year-to-date-losses, let alone declines since this energy down cycle began in mid-2014. But they’re clearly demonstrating the upside leverage survivors will have in the eventual recovery.

Selective on Energy Stocks, Cautious on Commodities

Two weeks ago, we noted energy stocks appeared to be breaking out of a multi-year trend of underperforming oil and gas prices on both rallies and dips. That trend has solidified since.

Oil has continued to slide. The market disruption that pushed the expiring May futures contract into negative territory has eased. But benchmark WTI Cushing is at a low to sub-teens price per barrel. Crude from Alaska, the Bakken and Canada has been trading under $10, and global benchmark Brent has periodically broken under $20.

The price of natural gas has been somewhat more stable. But after a mild winter in most of North America, benchmark Henry Hub is still well under $2 per thousand cubic foot. Gas at Canada’s AECO and Appalachia’s Marcellus is mired in the $1.50 range, too low for many producers to be profitable.

Energy Stocks Off Their Lows, Now What?

It’s still very early days to actually call it a trend. But for at least the last month, energy stocks are actually outperforming oil and gas prices.

That may be temporary. But at least for now, it’s a sharp break from the rule of the past several years. Since oil broke under $100 a barrel back in mid-2014, energy stocks have consistently lagged when oil has jumped. And when the price of the commodity has slipped, they’ve fallen much further and faster.

As a result, energy stocks have finished every mini-cycle of the past six years at lower levels. ExxonMobil’s (NYSE: XOM) March 31 bottom price of $30 and change is its lowest point since 2002.

Energy’s Great Guidance Re-Set

US oil prices are back in the neighborhood of $20 a barrel. And they’re showing every sign of going lower as COVID-19 fallout depresses demand and Saudi Arabia ramps up output like there’s no tomorrow.

Natural gas prices, meanwhile, have sagged under $1.70 per thousand cubic foot. They may catch a break on the supply front this year, as cutbacks of shale oil production reduce output of associated natural gas. But that may be more than offset by sagging demand, should efforts to reduce COVID-19’s spread result in a big drop in electricity usage.

The bottom line is energy producers are facing their worst operating environment since the early ‘00s. And unlike the last time prices dipped in 2015-16, their list of allies on Wall Street grows thin, all but cutting them off from economic outside financing. In effect, they’re on their own to generate the cash they need to operate.

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  • Portfolios & Ratings

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      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.

    Experts

    • 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