Monthly Commentary from Dan Pickering

After years in the doghouse, energy has been leading the stock market for the past few months.January saw Diversified Energy +4.3% (S&P1500 Energy, S15ENRS) with even better performance from Oilfield Services +5.6% (OIH), Midstream +5.8% (AMZ) and E&P +9.9% (XOP). The S&P500 fell -1.0% (which makes the energy performance even more impressive).WTI crude gained +7.6% (~$52.20/bbl) andfront month Henry Hub natural gas added +1.0% ($~2.56/mcf). The energy action in January was mostly macro.There were no eye-catching industry mergers and only a trickle of Q4 earnings reports.That doesn’t mean things were dull!

– WTI front month oil popped over $50/bbl as Saudi Arabia reduced production by 1mmbopd.Unexpected but welcomed by oil and energy stock traders alike.The 2021 NYMEX futures strip has improved to ~$50.90/bbl, but 2022-2025 remain stubbornly below $50/bbl (2022 ~$48.25, 2023 ~$46.90, 2024 ~$46.30, 2025 ~$46.10).With inventories above average, demand still soft from COVIDimpacts and OPEC’s 8mmbopd waiting to return to the market, low $50’s/bbl feels fair to slightly generous in the near term.It’ll feel fair-to-low by the end of the year, assuming COVIDvaccines continue to be administered and COVIDvariants don’t create a 4th wave of global lockdowns.

– We got our first look at the Biden administration’s stance toward the oil and gas business.The Keystone XL pipeline was canceled,and a 60-dayfreeze was placed on new drilling permits and leasing on Federal lands.Actions like these were a major concern for energy stocks leading up to the election, but investors were somewhat lulled by the quiet period from election to inauguration and the nice recent pop in crude prices.With a focus on a lower carbon future, the Biden presidency will be encouraging green energy and making life tougher for the conventional energy industry.Practicality will limit the pain –it is impractical to jam gasoline and home heating prices with overly punitive policies. However, the cost and hassle of being ahydrocarbon value chain participant is going to be higher.Truly an example of unintended consequences, this is structurally bullish for US oil/gas prices.Higher costs and supply restrictions put upward pressure on the commodities -which are already biased higher by lower spending and rising demand.Companies with existing production, acreage on non-Federal lands, and low-coststructures stand to be relatively more valuable.

– On the gasfront, the law of supply and demand once again showed dominance, this time in the LNG market.Cold weather in Asia took LNG prices to $15-$20/mcf (well over the equivalent of $100/bbl). When the market needs a commodity, prices respond. Inventory, price elasticity of demand and lead times for supply additions determine how long the dislocated prices can last.While it might not be 2021, we suspect we’ll see similar dislocations in oil markets at some point in the not-too-distant future.

– Peering over the fence at the energy transition, the stock market continued to pour huge amounts of capital into the concept of a lower carbon future. Hydrogen player Plug Power is a 10-bagger this year and did a $1.5B public offering that was substantially oversubscribed.SPACs announced half a dozen electric vehicle, electric charging and battery deals during January. Most of them carried multi-billion dollar valuations justified on 2024+ revenues. Meanwhile, GM announced its vehicle production would be all electric by 2035. For those dismissing the energy transition as a fad –don’t. The capital allocation may wind up being misguided (i.e. allocating dollars to the wrong things), but the intent behind the allocation isclear. The world is headed toward lower carbon. Every time we make this statement, we also feel compelled to remind people this lower carbon future will take decades to achieve, with traditional oil and gas players being the backbone energy providers.

– From the outhouse to the penthouse, energy stocks have started 2021 as the S&P500’s best performing sector. During January, the broad market lost ground (S&P500 -1.0%), while S&P500 Energy gained +3.8%. The next closest sector was S&P500 Health Careat +1.4%. Therally in oil prices was the January catalyst, with a dollop of momentum from the sector’s ongoing bounce off the bottom.Trading action in OFS stocks was revealing.The Big Three –Schlumberger, Halliburton and Baker Hughes -all reported earnings above consensus expectations.None of the stocks traded particularly well -a sign the market is digesting recent strength (OIH +89.4%from October 30, 2020 to January 18, 2021). However, National Oilwell preannounced a sizeable Q4 earnings miss, but the stock was only off -5.9% on the day of the announcement, following a +75.6% rallyin the preceding few months. We believe investors want to see financial follow through from the energy sector, but sentiment has shifted more toward dip-buying than rally selling. While we expect the sector to be volatile in 2021, energy’s strong start is not a fluke.

– We’d feel out of touch if we didn’t at least mention the ongoing headline issues around retail investors, Reddit, GameStop, other YOLO stocks, short squeezes and what some are calling “the changing nature of investing”.Retail investors are rallying around each other to aggressively buy and squeeze several highly shorted stocks. Some are calling this a rebellion. Some are calling this a populist movement. Regardless of what it is, unsettling things are happening. Clearing institutions raised capital requirements. Broker Robinhood pulled on credit lines and received an equity infusion. Unsophisticated investors are being lured into the market by hopes of outsized gains. Convenient trading platforms, work from home schedules and easy/cheap leverage are resulting in high volumes and amplified risk. This almost never ends well for investors that come later to the party. It usually winds up with outrage and calls for increased market regulation. That social media and (often anonymous) individuals are the Medusa for the current frenzy is a new wrinkle. A few energy names have seen some short squeeze behavior, but the sector has mostly been ignored. We have not adjusted our Fund’s portfolio or cash position but have an action plan to raise cash if markets become less stable.

As always, we welcome your questions and appreciate your interest.

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