January 2023 – Commentary from Dan Pickering

Now that’s how you start a year. January saw the stock market explode out of the gates with the S&P500 rallying +6.3% and the Nasdaq Composite jumping +10.7%...

Now that’s how you start a year.  January saw the stock market explode out of the gates with the S&P500 rallying +6.3% and the Nasdaq Composite jumping +10.7%.  At +3.0%, Diversified Energy (S&P 1500 Energy, S15ENRS) lagged the broad indices, with subsector performance as follows – Oilfield Services +8.6% (OIH), Midstream +6.5% (AMZ), and Upstream/E&P +3.7% (XOP). Clean energy added +4.5% (ICLN).  Crude oil fell -1.7% (~$78.90) while natural gas continued its implosion by falling -40% (~$2.70/mcf).(1)

Items of note during January and early February:

  • Optimism was rampant in January.  Remembering that bad news is good news for those expecting interest rates to moderate, January’s economic data was just bad enough to spark a meaningful rally.  Bullish technical levels were breached to the upside and FOMO kicked in.  This is either the proverbial Wall of Worry being climbed or a sweet-smelling honey pot squeezing out the bears before a pullback.  With call option volume hitting the highest level in history on February 2nd and meme stocks ramping, we’re inclined to tread carefully.
  • Natural gas gapped down again as warm weather across the globe took down European prices (one year forward TTF dropped from ~89€/MWh to ~63€/MWh) and the US as well.  It appears that US market participants are going to sell/short natural gas until the industry starts to moderate supply via lower drilling and completion activity.  We’ve heard anecdotes of an impending rigcount slowdown among a few gassy private operators, but it does not appear that gassy public E&Ps have blinked yet.  We expect they will with any longevity of Henry Hub prices around $2.50/mcf (currently ~$2.40/mcf).
  • Looking ahead in the oil macro, sanctions on Russian products will begin in early February.  Oil sanctions have been a nothing-burger (so far), so perhaps the same will be true of products.  The market feels a bit lulled to sleep on Russia – which is always when hell breaks loose.  We continue to “take the over” on long-dated oil futures – 2025 closed January at ~$69.10 and feels too cheap in a world that has underinvested in supply.
  • At the early February meeting, OPEC rolled its current production levels.  Expected and overall supportive, a trend we believe will continue for the foreseeable future.
  • Cracks are beginning to appear in the US oilfield service story.  We’ve heard a number of oily players complain of deteriorating well economics due to increased well costs and the pullback of oil prices into the $70’s.  With gas economics adding insult to injury, the anecdotes are emerging of US rig rates pulling back from recent highs, tubulars getting easier to find and gaps developing in frac schedules.  Absolute levels of profitability are still solid for oilfield service players, but the momentum seems to be shifting back to E&P customers.
  • In conjunction with its Q4 earnings results, European major BP announced it would invest $8B more in hydrocarbon projects between now and 2030.  This will result in a production drop of -25% vs. 2019 levels, a bump up from the prior guidance of -40%.  Carbon emissions will also be reduced less than previously targeted.  BP cloaked this move in terms of adapting to Russia’s invasion of Ukraine and the subsequent shifting energy priorities of global governments.  We agree Russia/Ukraine has changed the calculus (recall our 10-months-in-a-row Trustworthy Barrels mantra from 2022).  However, we see BP’s move as crying uncle – the stock has been a dramatic underperformer since its February 2020 pivot toward renewables.  While the environmental community will probably tear the company to shreds for backpedaling, investors clearly liked the move.  BP’s stock jumped +8.3% (vs. XLE +3.2%) on the date of BP’s announcement.
  • The cash generating power of the energy sector has been reinforced during Q4 earnings, most notably with Chevron’s $75B share repurchase authorization.  Capital discipline remains excellent across the sector.  On a relative basis, Conoco’s uptick in capex guidance was punished by investors.  This certainly seems to indicate return-of-capital remains a higher priority to institutional players than hydrocarbon production growth.
  • Energy stocks held up well in January considering commodities were uninspiring and money was chasing/rotating toward tech.  The crowd that ramps Nvidia isn’t (yet) the same crowd that generally owns energy.  It isn’t fair to call energy slow-and-steady considering all the macro/micro dynamics and volatility, but we’re happy to plod ahead with status quo behavior in the energy sector – it’ll be a winner over the next few years.

Please remember the PEP organization is standing by to help – whether it be investment exposure, capital needs, energy market intelligence or help with a specific problem. As always, we appreciate your interest and welcome your questions.

  1. Source: Bloomberg