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Industry Report – Energy – Energy Sector Remains Hot

Energy
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Monday, October 4, 2021

Energy Industry Report

Energy Sector Remains Hot

Michael Heim, CFA, Senior Research Analyst, Noble Capital Markets, Inc.

Refer to end of report for Analyst Certification & Disclosures

  • Energy stocks started off weak but finished strong. Energy stocks, as measured by the XLE Energy Index, declined sharply in the first half of the quarter falling as much as 16%. The second half of the quarter was a different story with the index regaining lost ground and finishing within 0.04 points, or 0.01% of where it began.
  • Stock performance followed oil prices. WTI oil prices began the quarter at $75.23/bbl., fell to as low as $62.32/bbl., and then shot up sharply to $75.88/bbl. One would have to go back to 2014 to find higher oil prices. What’s more, oil prices show no signs of letting up. Drilling rig count has started to increase, but not at a level one would expect for this oil price level. The WTI oil futures curve shows oil prices declining on the out months but staying above $74/bbl. through December.
  • The rise in oil prices is impressive, but it pales in comparison to the jump in natural gas prices. Henry Hub gas prices rose 53% during the quarter and are now trading at a level of $5.619/mcf. One would have to go back to 2008 to find natural gas prices this high. Interestingly, the rise has come during the normally quiet summer months. The race to refill storage units that began in March has been negatively impacted by tepid drilling activity combined with high gas demand due to hot weather this summer. Natural gas future prices rise through the high-demand months of winter. The January contract, for example, trades at $5.85/mcf.
  • The rebound in oil and natural gas prices came faster than expected and is staying higher than we would have expected. We have been adjusting our models to reflect higher prices but are maintaining our long-term oil price forecast of $50 per barrel and $2.50 per mcf. Energy companies should start reporting positive cash flow at these prices and increasing drilling budgets. Our near-term outlook for energy stocks remains positive. Wells being drilled today at current prices are generating cash flow to repay drilling costs in a matter of months, not years. We expect companies to report favorable results for the next few quarters. We recommend investor shift their attention to companies with active drilling programs and a plethora of drilling options.

Energy Stocks Performance

Energy stocks, as measured by the XLE Energy Index, declined sharply in the first half of the quarter falling as much as 16%. The second half of the quarter was a different story with the index regaining lost ground and finishing within 0.04 points, or 0.01% of where it began. This is in direct contrast to the S&P 500 Index which rose steadily in July and August before giving back much of its outperformance in September and ending the quarter up a modest 0.85%

 

Oil Prices

As one might expect, the XLE Index largely mirrored oil prices. WTI oil prices began the quarter at $75.23/bbl., fell to as low as $62.32/bbl., and then shot up sharply to $75.88/bbl. Prices have surpassed peak levels reached in 2018. One would have to go back to 2014 to find higher oil prices. What’s more, oil prices show no signs of letting up. Drilling rig count has started to increase, but not at a level one would expect for this oil price level. Brent oil prices have also been strong and are close to crossing $80/bbl. The spread between Brent and WTI prices has widened but remain below the traditional spread of around $5/bbl. The WTI oil futures curve shows oil prices declining on the out months but staying above $74/bbl. through December.

High oil prices, combined with improved operating efficiencies mean that production companies are facing very favorable returns on their investment. We look for companies to start reporting strong positive cash flow and to use cash flow to increase drilling and improve balance sheets. We do not expect companies to raise dividend payments given the cyclical nature of recent oil price trends but would not rule out share repurchases if stock prices do not rebound further.

 

Natural Gas Prices

The rise in oil prices is impressive, but it pales in comparison to the jump in natural gas prices. Henry Hub gas prices rose 53% during the quarter and are now trading at a level of $5.619/mcf. One would have to go back to 2008 to find natural gas prices this high. Interestingly, the rise has come during the normally quiet summer months. The race to refill storage units that began in March has been negatively impacted by tepid drilling activity combined with high gas demand due to hot weather this summer. Natural gas future prices rise through the high-demand months of winter. The January contract, for example, trades at $5.85/mcf.

 

Longer-term energy trends

Energy sources in the United States are undergoing a significant transformation away from carbon-based fuels. While this should not be a surprise to anyone, it is worth taking a long-term view of energy consumption to highlight how the transformation has accelerated in recent years. Coal consumption has been replaced by renewable, nuclear, and natural gas. Worth noting, petroleum consumption, which grew dramatically in the last 50 years, has maintained the levels reached at the end of the century. We believe this trend will continue with petroleum providing a smaller portion of the overall energy picture, but not necessarily declining in absolute value.

 

Outlook

The rebound in oil and natural gas prices came faster than expected and is staying higher than we would have expected. We have been adjusting our models to reflect higher prices but are maintaining our long-term oil price forecast of $50 per barrel and $2.50 per mcf. Energy companies should start reporting positive cash flow at these prices and increasing drilling budgets.

Our near-term outlook for energy stocks remains positive. Wells being drilled today at current prices are generating cash flow to repay drilling costs in a matter of months, not years. We expect companies to report favorable results for the next few quarters. Longer-term, we have concern that oil demand will be constrained by power generation competition from renewable energy and decreased demand for gasoline and diesel due to a growth in electric vehicles. At the same time, increased supply from OPEC and continued drilling productivity will eventually mean lower energy prices. However, the near-term returns are so favorable, we believe investors will be amply rewarded before such a time arrives. We recommend investor shift their attention to companies with active drilling programs and a plethora of drilling options.

GENERAL DISCLAIMERS

All statements or opinions contained herein that include the words “we”, “us”, or “our” are solely the responsibility of Noble Capital Markets, Inc. (“Noble”) and do not necessarily reflect statements or opinions expressed by any person or party affiliated with the company mentioned in this report. Any opinions expressed herein are subject to change without notice. All information provided herein is based on public and non-public information believed to be accurate and reliable, but is not necessarily complete and cannot be guaranteed. No judgment is hereby expressed or should be implied as to the suitability of any security described herein for any specific investor or any specific investment portfolio. The decision to undertake any investment regarding the security mentioned herein should be made by each reader of this publication based on its own appraisal of the implications and risks of such decision.

This publication is intended for information purposes only and shall not constitute an offer to buy/sell or the solicitation of an offer to buy/sell any security mentioned in this report, nor shall there be any sale of the security herein in any state or domicile in which said offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state or domicile. This publication and all information, comments, statements or opinions contained or expressed herein are applicable only as of the date of this publication and subject to change without prior notice. Past performance is not indicative of future results.

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IMPORTANT DISCLOSURES

This publication is confidential for the information of the addressee only and may not be reproduced in whole or in part, copies circulated, or discussed to another party, without the written consent of Noble Capital Markets, Inc. (“Noble”). Noble seeks to update its research as appropriate, but may be unable to do so based upon various regulatory constraints. Research reports are not published at regular intervals; publication times and dates are based upon the analyst’s judgement. Noble professionals including traders, salespeople and investment bankers may provide written or oral market commentary, or discuss trading strategies to Noble clients and the Noble proprietary trading desk that reflect opinions that are contrary to the opinions expressed in this research report.

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Company Specific Disclosures

The following disclosures relate to relationships between Noble and the company (the “Company”) covered by the Noble Research Division and referred to in this research report.

Noble is not a market maker in any of the companies mentioned in this report. Noble intends to seek compensation for investment banking services and noninvestment banking services (securities and non-securities related) with any or all of the companies mentioned in this report within the next 3 months.

ANALYST CREDENTIALS, PROFESSIONAL DESIGNATIONS, AND EXPERIENCE

Senior Equity Analyst focusing on energy and utility stocks. 24 years of experience as an analyst. Chartered Financial Analyst©. MBA from Washington University in St. Louis and BA in Economics from Carleton College in Minnesota. Named WSJ ‘Best on the Street’ Analyst four times. Named Forbes/StarMine’s “Best Brokerage Analyst” three times. FINRA licenses 7, 63, 86, 87.

WARNING

This report is intended to provide general securities advice, and does not purport to make any recommendation that any securities transaction is appropriate for any recipient particular investment objectives, financial situation or particular needs. Prior to making any investment decision, recipients should assess, or seek advice from their advisors, on whether any relevant part of this report is appropriate to their individual circumstances. If a recipient was referred to by an investment advisor, that advisor may receive a benefit in respect of transactions effected on the recipients behalf, details of which will be available on request in regard to a transaction that involves a personalized securities recommendation. Additional risks associated with the security mentioned in this report that might impede achievement of the target can be found in its initial report issued by . This report may not be reproduced, distributed or published for any purpose unless authorized by.

RESEARCH ANALYST CERTIFICATION

Independence Of View

All views expressed in this report accurately reflect my personal views about the subject securities or issuers.

Receipt of Compensation

No part of my compensation was, is, or will be directly or indirectly related to any specific recommendations or views expressed in the public appearance and/or research report.

Ownership and Material Conflicts of Interest

Neither I nor anybody in my household has a financial interest in the securities of the subject company or any other company mentioned in this report.

NOBLE RATINGS DEFINITIONS % OF SECURITIES COVERED % IB CLIENTS
Outperform: potential return is >15% above the current price 84% 30%
Market Perform: potential return is -15% to 15% of the current price 3% 1%
Underperform: potential return is >15% below the current price 0% 0%

NOTE: On August 20, 2018, Noble Capital Markets, Inc. changed the terminology of its ratings (as shown above) from “Buy” to “Outperform”, from “Hold” to “Market Perform” and from “Sell” to “Underperform.” The percentage relationships, as compared to current price (definitions), have remained the same.

Additional information is available upon request. Any recipient of this report that wishes further information regarding the subject company or the disclosure information mentioned herein, should contact Noble Capital Markets, Inc. by mail or phone.

Noble Capital Markets, Inc.
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Boca Raton, FL 33432
561-994-1191

Noble Capital Markets, Inc. is a FINRA (Financial Industry Regulatory Authority) registered broker/dealer.
Noble Capital Markets, Inc. is an MSRB (Municipal Securities Rulemaking Board) registered broker/dealer.
Member – SIPC (Securities Investor Protection Corporation)

Report ID: 24083

Energy | October 4, 2021

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