.webp)
December was an OK finish to a very good year. While the S&P500 gained +4.4%, Diversified Energy gained +2.8% (S&P 1500 Energy, S15ENRS), with the following energy subsector performance – Upstream/E&P -1.6% (XOP), Midstream +3.6% (AMZ) and oilfield services +3.6% (OIH). WTI oil rallied nicely +13.6% (~$75.20/bbl) and Henry Hub natural gas declined -18.3% (~$3.70/mcf).
Oil markets fought their way back from a string of negative data points and overhangs. Covid’s Omicron variant has driven a record number of cases, but fewer deaths and hospitalizations. The release/swap of barrels from the US Strategic Petroleum has moved ahead. As indicated in its December meeting, OPEC+ has continued to bring incremental barrels back to the market. Despite these issues, oil prices are holding nicely. After WTI’s Omicron dip in late November into the mid$60s/bbl, oil rallied back to the low $70s. It took another short trip into the $60s with the negative market reaction to impending Fed tightening and the failure to achieve passage of the Build Back Better plan. And once again WTI bounced back into the $70s along with the overall end-of-year stock market rally. We’re encouraged by what feels to be a strong floor in the $65/bbl range.
Fundamentally, it is worth noting that 2021 oil and gas discoveries (new reserves added via drilling) are likely to be the lowest in decades. This is not surprising given the low levels of reinvestment from the upstream players, but it is a reminder that hydrocarbon production is a capital-intensive process that requires drilling to offset natural declines. OPEC+ barrels can meet incremental demand during 2022, but 2023 is certainly feeling tighter on the supply side.
On the natural gas front, cold weather in Europe drove fresh new highs for European natural gas prices (near $200/bbl equivalent) and has pulled LNG cargoes toward that continent like moths to a flame. Price is rationing and allocating supply as it usually does when fundamentals are tight. Meanwhile, warm US weather moderated near-term Henry Hub prices to the $3.60/mcf level before the first meaningful cold snap popped them back above $4/mcf to finish the year. We would take the under on the current ~$3.70/mcf NYMEX futures strip for 2022, but still expect a decent year after spending the last few in the doghouse.
Turning to energy transition, Senator Manchin’s opposition to the Build Back Better plan was a psychological and financial hit to vehicle electrification and charging. Some of the expected support/subsidies must now wait for a revised bill or other legislation. However, electrification remains a juggernaut. The Biden administration issued an executive order which mandates, by 2035, all government vehicles purchased will be zero-emission. We haven’t changed our view that decarbonization is a megatrend. A lower carbon future is coming, but the path will be choppy and volatile. Highlighting this volatility, after jumping +140% in 2020, the Ishares Global Clean Energy ETF (ICLN) dropped -25% in 2021. We are searching for public equity opportunities within this (relative performance) wreckage, as well as for good risk-reward decarbonization private equity investments.
Despite coming off a stellar year with performance of +48.6% for the S&P1500 Energy benchmark, we feel good about the prospects for continued absolute and relative performance for energy stocks in 2022. Oil price is likely to trade in a $65-$85/bbl range, while the equities currently discount closer to $55/bbl and are trading at 4-5x cash flow and 10%+ free cash yields. Although a commodity price uptick probably won’t be a catalyst in 2022, the duration of capital discipline creates the very real potential for energy stock re-rating. Investors spent much of 2021 being skeptical the oil and gas industry could adjust its business model to capital discipline and returning cash to shareholders. Quarter after quarter after quarter of energy companies holding the line will eventually convert the skeptics. There’s another double in many energy stocks when they begin to discount $65/bbl long-term oil (current 2025 NYMEX futures strip is ~$60/bbl) and trade closer to 5-7x cash flow (still well below historical averages). Unless/until the fundamental outlook changes for either the energy or economic macro, we’re along for that ride!
The end of the year is always a good time to reflect on the past and think about the future. Even though it was choppy and difficult, 2021 was traditional energy’s best in quite a while. 2022 feels like more of the same. It will be a hard-fought, wall-of-worry year that is likely to be nicely profitable. Energy transition and decarbonization emerged as a Megatrend (our opinion) during 2021. Finding ways to make money in this expensive arena remains the key challenge and opportunity for clean energy investors. For the foreseeable future, the biggest overarching energy theme, which is non-consensus, will be “all-of-the-above”. Hydrocarbons, renewables and new energy technologies can and must co-exist in order for the world to have accessible, reliable, reasonably priced and lower-carbon energy. We look forward to navigating these unique times alongside you – our friends and clients.
As always, we appreciate your interest and welcome your questions. Wishing you the best in 2022!
The above information does not constitute investment advice. Please note that these unaudited estimates have been prepared in accordance with our typical procedures for estimates and as such, final month-end prices may not have been received for all positions. Performance for all strategies is net of fees. Returns have been adjusted where applicable to reflect the highest level of fees available. The PEP Energy Equity Opportunities strategy performance is that of an investor invested in the USD share class of the one-year tranche. The performance calculation assumes that the investor’s account participated fully, on an applicable pro forma basis, in all investments, and was assessed a 1% management fee and 10% incentive fee. Additionally, the performance calculation assumes that all investors were given the same economic terms with respect to their investment. From Inception (May 1, 2022) the performance of the PEP TE&M Opportunities Fund is calculated pro forma to represent the highest fee level offered for the strategy. The performance calculation assumes that the investor’s account participated fully, on an applicable pro forma basis, in all investments, and was assessed a 1.5% management fee and 20% incentive fee subject to high water mark. Additionally, the performance calculation assumes that all investors were given the same economic terms with respect to their investment. Individual investors’ returns will vary from the strategy returns due to the timing of subscriptions and redemptions. Indexes are unmanaged and have no fees or expenses. An investment cannot be made directly in an index. The strategies represented consist of securities which may vary significantly from those in the indices listed in the Estimated Net Performance Benchmark chart, and performance calculation methods may not be entirely comparable. Accordingly, comparing results shown to those of the aforementioned indices may be of limited use. Please refer to fund documents for terms and appropriate risk disclosures. As a reminder, please note that the information provided is confidential and should not be forwarded or distributed by any recipient. If you would like to add someone to the distribution list or have any questions, please feel free to contact us at ClientServices@PickeringEnergyPartners.com.
