Equity Research Report Release
Tuesday, October 8, 2019
Energy Industry Report
Summer's End Brings No Relief For Energy Stocks
Michael Heim, CFA, Senior Research Analyst, Noble Capital Markets, Inc.
Refer to end of report for Analyst Certification & Disclosures
- Energy stocks fell 9% underperforming the overall market by 8% for the second straight quarter. The decline matches the drop in oil prices. Natural gas prices were flat, which is not uncommon for the summer quarter.
- Oil prices fell 9% as two spikes proved to be short lived. Oil prices crossed above $60/BBL twice in response to Persian Gulf tension, but quickly declined when conflicts did not escalate. Oil inventories continue to rise as the U.S. approaches the point of being a net energy exporter. Investor focus has shifted to a slowing global economy.
- A sustained period near $50/BBL could put pressure on energy companies. The long-term futures curve is flat. Hedges are rolling off and companies are being forced to work to lower capital expenditures and operating costs to stay within operating cash flow. Smaller companies with weak balance sheets may face liquidity issues.
- We remain cautious on the group. We favor companies with low debt levels, high hedge positions and low operating costs.
Energy stocks reported another disappointing quarterly as oil prices continued their decline. The XLE Energy Select Sector SPDR Fund fell 9.3% over the three months ended September 30, 2019. This compared to a decline of 1.3% for the S&P 500 Index. This is the second consecutive quarter in which the XLE has underperformed the overall market by approximately 8%. As is usually the case, one need only to look at the performance of oil prices to explain the poor stock performance.
Oil prices, as measured by the WTI November 2019 future price, declined 9.3% from $59.14 per barrel to $53.62 per barrel. The path downward, however, was anything but steady. Oil prices rose sharply in June and again in September to levels above $60 per barrel in response to tension in the Persian Gulf. Higher prices were short lived. Both times, oil prices sank $10 per barrel to a level in the low fifties in the three weeks following the rise. Natural gas prices, as measured by Henry Hub November 2019 futures, were essentially flat rising a modest 0.8% from $2.266 per thousand cubic feet (mcf) to $2.283 per mcf. This is not unusual during the summer quarter when there are few heating degree days.
Oil inventories continue to rise with the EIA reporting consolidated oil stocks of approximately 2 million BBLS (as of 9/27), up 1.7% from a year ago. Of note, domestic production rose approximately 15% year over year and net imports fell 33%. The EIA estimates that the United States could become a net exporter of energy in 2020. Rising domestic production, combined with concerns of a global economic slowdown, seem to be having a bigger impact on oil prices than political tension in the Persian Gulf.
The oil future’s curve is relatively flat at prices near current levels. Many energy companies took advantage of the oil price spikes to add to their hedge positions. For those who didn’t, the opportunity has passed. Longer-term oil prices do not show any relief to producers.
The current outlook for the energy sector remains somewhat negative. Companies are under pressure to lower their operating costs to justify production at $50 per barrel prices. Most companies try to limit expenses to a level within their generated cash flow. With prices down, that means cutting back on operating costs and capital expenditures. A prolonged period at prices near or below $50 per barrel could test the liquidity of companies with burdensome debt levels or high operating costs.
We remain cautious regarding energy stocks. We favor companies with low debt levels, high hedge positions and low operating costs.
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Senior Equity Analyst focusing on Basic Materials & Mining. 20 years of experience in equity research. BA in Business Administration from Westminster College. MBA with a Finance concentration from the University of Missouri. MA in International Affairs from Washington University in St. Louis.
Named WSJ 'Best on the Street' Analyst and Forbes/StarMine's "Best Brokerage Analyst.”
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Report ID: 11091