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  • Roger S. Conrad

Issues

Energy Returns are Rising, and the Best is Yet to Come

Last week, North American benchmark crude oil prices hit their highest level since October 2014. And while natural gas has backed off from this month’s peak, the fuel continues to trade a stone’s throw away from its highest price since mid-2008.

These higher commodity prices are the inevitable consequence of years of underinvestment in oil and gas production and infrastructure, which in hindsight really stretch back to when oil traded comfortably over $100 a barrel in mid-2014. Nonetheless, we still expect energy companies to hold the line on spending when they update their guidance over the next few weeks.

The New Energy Crisis

For the first time in four decades, inflation is a key risk in the US and other developed economies.

Indeed, according to the University of Michigan survey, US consumers expect annualized inflation of close to 3% over the long haul, a full 1% above the Fed’s 2% target level.

Meanwhile, more than 50% of small businesses in the National Federation of Independent Business (NFIB) survey reported that job openings were hard to fill in the month of August 2021, the highest reading in the history of this survey dating back to 1973.

Rising labor costs prompted FedEx (NYSE: FDX) to slash guidance in September while expectations for Q3 2021 US economic growth have plummeted since August as many fret that rising prices are beginning to pinch the consumer.

Time is Running Out to Catch Energy in 2021

There’s little more than three months left in 2021. And time is rapidly running out for energy-light investors and their advisors to catch up to the sizzling performance of oil and gas stocks.

The S&P 500 Energy Index has returned better than 31 percent year to date, or nearly 12 percentage points more than the S&P 500 as a whole. And oil and gas stocks are even further ahead of the companies conventional wisdom says will replace them: The Invesco Solar ETF (NYSE: TAN) is underwater by -18 percent year-to-date, while the ARK Innovation ETF (NYSE: ARKK) is lower by more than -5 percent.

Extraordinary Energy Values in a Zero Rate Environment

Where do you find stocks offering near double-digit yields backed by businesses repeatedly posting strong results? In this zero interest rate environment, our answer would ordinarily be “dream on.” But that’s exactly the kind of value the Energy and Income Advisor Model Portfolio and High Yield Energy Target List offer now. And Q2 numbers and guidance updates have once again proven their financial strength and upside leverage to the energy price cycle. This issue’s Portfolio section has the run down for the 23 Portfolio and High Yield List companies that had not reported as of our previous EIA issue—where we unpacked results for Kinder Morgan Inc (NYSE: KMI), Schlumberger Ltd (NYSE: SLB) and Texas Instruments (NYSE: TXN).

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.

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  • Live Chat with

    Elliott and Roger on Oct. 28, 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.

    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