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  • Roger S. Conrad

Finding Value in Canada

By Roger S. Conrad on Jul. 21, 2019

The big oil price collapse that prompted a bear market in energy stocks and Master Limited Partnerships (MLPs) started 5 years ago this summer.

There were two crucial changes – discussed at length in these pages in late 2014 – that prompted the collapse. First, the US shale revolution kicked into high gear as improvements in technology and efficiency helped propel US oil production to all-time record highs. Just consider: the US is now the world’s largest producer of crude oil, a fact that would have been considered inconceivable a decade ago.

Second, OPEC recognized this shift and was unwilling to continue to accommodate shale’s rising shale production through a never-ending string of production cutbacks and lowered quotas.

These two key changes, not fully appreciated by most market participants, were behind our 2014 sell calls in crude oil and many popular energy stocks.

Today, 5 years post-collapse, we believe the market is once again failing to appreciate 2 crucial changes now underway. First, US oil production growth is slowing because Wall Street is no longer rewarding growth for growth’s sake – the US oil-directed rig count has plummeted by more than 100 rigs since the end of 2018 despite a sizable rising in crude oil prices.

Second, OPEC – and Saudi Arabia in particular – is no longer focused on defending market share and they clearly see the slowdown in US oil output underway. Frankly, the larger producers – again Saudi Arabia springs to mind – simply can’t continue to support prices in the $50/bbl range long-term given their current budgets.  

Thus, OPEC is willing to cut production to prevent oversupply in the short run, even at the expense of market share losses. In short, they’re likely to be unwilling to allow prices to tumble below $50/bbl for any serious length of time.

These shifts in industry dynamics are also behind a gradual healing in energy-related stocks.

It’s true that the S&P 500 Energy Index is the second-worst performer in the S&P this year, up less than half as much as the index as a whole. However, there are several major pockets of strength.

Case in point: The Alerian MLP Index, a group many left for dead in the spring of 2018, is up around 19.2% year-to-date and offers an unmatchable yield proposition as the Fed now prepares to cut rates.

Eventually, we also believe rising free cash flow from shale producers and accompanying shareholder-friendly moves such as debt reduction, share buybacks and dividends will be difficult for investors to ignore. As such, the group is due a major upside re-rating.

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    • 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