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A continued grind. During October, the S&P500 fell -0.9%, the Nasdaq dropped -0.5% and energy was soft as Diversified Energy added +0.8% (S&P 1500 Energy, S15ENRS), with other energy subsector performance: Midstream -1.3% (AMZ), Upstream -0.6% (XOP), Oilfield Services -3.2% (OIH) and Clean Energy -10.8% (ICLN). October saw front month WTI increase +1.6% (to ~$69.25/bbl), while Henry Hub natural gas volatility continued with a decline of -7.4% (to ~$2.70/mmbtu).(1)
It has been a busy five weeks since the start of October.
- Israel struck back at Iran, although energy and nuclear facilities were intentionally avoided. Israel’s allies continue to exert pressure to avoid actions that would 1) dramatically escalate the Middle East conflict and 2) potentially bump oil/gasoline prices, particularly in front of US elections. Once again, lackluster crude markets made the correct assumption that Middle East tensions would not result in any meaningful supply disruptions. Tail risk remains, but is largely unpriced at low $70's WTI.
- The US election left no uncertainty, resulted in no violence and sparked a big stock market rally on the day after Trump won the Presidency (+2-3% for the broad indices). Conventional energy outperformed nicely (+3-8% across the various subsectors), while clean energy was crushed (ICLN -8%, with many individual names down 15-50%). The clean energy selloff was probably too dramatic given what will actually happen when Trump takes office, but uncertainty rules in the meanwhile.
- Importantly, we think any Trump commentary or exhortation around “drill, baby, drill” will fall on deaf E&P ears. There is no incentive for a change in E&P behavior - why produce meaningfully more oil into a global oil market that has overcapacity (OPEC+) and an already-sloppy supply/demand balance, while potentially jump-starting another market share battle with OPEC+? The industry has come too far since the shale bust to fall victim to an unforced error.
- At its early November meeting, OPEC+ delayed its scheduled return of production by another month, from December into early 2025. We expect this to continue for the indefinite future. There is absolutely no room for more OPEC+ barrels in 2025. And a price-focused OPEC is not going to shoot itself in the foot (in our opinion).
- In its next legislative session in early 2025, the state of New Mexico will potentially consider stricter rules regarding drilling setbacks (how far away from certain types of structures a well can be drilled). With 40%+ of state revenues coming from the oil and gas industry, we suspect the politicians won't kill the golden goose, but we'll be monitoring the situation closely.
- On the M&A front, companies continue to optimize portfolios and look for scale. Chevron sold $6.5B worth of Canadian heavy oil and shale assets to Canadian Natural Resources Limited (CNRL), Diamondback Energy swapped some Delaware Basin assets for Midland Basin assets and Nabors Industries announced a merger with Parker Wellbore (a combination we've thought made sense for 20+ years). Additionally, M&A rumors were flying with Coterra (CTRA) for Ovintiv (OVV) as a deal we are skeptical about, while we put more credence behind offshore OFS provider Helix (HLX) as a takeout candidate.
- With respect to takeaways from earnings, the message from the E&P industry is one of continued capital discipline and free cash generation. This showed up with softer Q4 guidance from the OFS sector as customer budget exhaustion means fewer rigs running in November and December. Refiners generally had weak quarters, with the most notable being CVR Energy (CVI), which suspended its dividend in the near-term to reflect unplanned and impending downtime. The -25% one-day reaction of the stock tells us that disappointments in the conventional oilpatch will not be tolerated.
With an industry-friendly US president and continued evidence of a price-focused OPEC+, perhaps stocks in the energy sector can begin to catch a bid. Value is certainly compelling. Whether investors can pry themselves away from technology remains to be seen. A "broadening out" of the market would be helpful and welcome for energy stocks.
(Source: Bloomberg)
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