June 2023 – Commentary from Dan Pickering

Oil remains a meandering commodity, trading around $70/bbl as market participants await macroeconomic clarity. Industry players continue to take matters into their own hands via active consolidation…

Traditional Energy Monthly Commentary

June 2023 - a nice bounceback month for energy.  While both the S&P500 and the Nasdaq Composite advanced ~+6.7% for the month, Diversified Energy (S&P 1500 Energy, S15ENRS) gained +7.1% with subsector performance as follows - Oilfield Services +16.5% (OIH), Upstream/E&P +9.8% (XOP), Midstream +4.1% (AMZ) and Clean Energy +1.0% (ICLN). Front month WTI crude oil ticked up +3.7% (~$70.60/bbl) and natural gas volatility continued with a jump of +23.5% (~$2.80/mmcf) for front month Henry Hub.(1)

Oil remains a meandering commodity, trading around $70/bbl as market participants await macroeconomic clarity.  OPEC+ pronouncements and actions have inspired neither confidence nor a price rally, leaving us in the Show-Me market we described last month.  Inventories are the key.  We believe they will draw notably in 2H 2023 and are comforted by the August extension of Saudi’s recent 1mmbopd production cut.  Given the Saudi “whatever is necessary” language, we suspect their cut will be extended until price/inventory responds.  Thus, the tail-chasing commodity game continues until something breaks out or breaks down.  We believe the former.

Industry players continue to take matters into their own hands via active consolidation.  US land driller and pressure pumper Patterson Energy (PTEN) made two significant acquisitions, merging with public competitor NexTier Oilfield Solutions (NEX) and private drillbit manufacturer Ulterra Drilling Technologies in deals valued at ~$2.4B and ~$825MM, respectively.  In the E&P sector, the Permian continued to see multibillion dollar deals as Earthstone Energy (ESTE) and Northern Oil & Gas (NOG) teamed up to buy private Novo Oil & Gas ($1.5B deal), while Civitas (CIVI) bought privately-held Tap Rock Energy (~$2.5B) and Hibernia Energy (~$1B).  

Several themes are evident in the transactions above.  1) Public energy companies are playing offense and trying to grow via acquisitions given they are constrained (by investors) from growing organically via capex.  2) Public energy companies are pushing hard for relevance in a stock market that isn’t paying much attention to small caps.  All the June buyers were sub-$6B market cap companies.  3) Energy private equity is monetizing.  Ulterra was backed by Blackstone, Novo was an EnCap portfolio company and NGP owned both entities purchased by Civitas.  In all instances, the PE firms are taking some portion of deal consideration in stock, so the exits aren’t complete.  However, PE is taking more dollars out of the sector than they are investing (more on this in future writeups).

As we hit the halfway point of the year, it is worth a quick recap of energy stock performance on an absolute and relative basis.  In a vacuum, both are uninspiring.  The S&P1500 Energy Index is −5.4% YTD, while Clean Energy is −6.7% (ICLN), Oilfield Services are −5.4% (OIH) and E&P is −3.8% (XOP).  Midstream is the only subsector to generate positive performance YTD at +9.6% .  Everything in energy pales next to the S&P500 at +16.9% and the smoking-hot Nasdaq at +32.3%.  

After several years as the best group in the market, it is not hugely surprising to see energy taking a breather.  However, the magnitude of that breather seems overly distorted given decent oil prices (albeit disappointing vs. expectations and -12% YTD) and inexpensive energy valuations (2-4x cash flow), particularly compared to an expensive S&P500 (double digit cash flow multiples).  The summer may be more of the same, but we expect to see a tighter spread between energy and the broad market by YE2023.  Patience is a virtue - something we have to relearn/endure all too frequently.

Decarbonization / Energy Transition Quarterly Commentary

2023’s tough grind for clean energy continued in Q2.  While Q2 saw the S&P500 gain +8.7% and the Nasdaq Composite advance +13.1%, the iShares Global Clean Energy ETF (ICLN) fell −6.4% and conventional energy declined −0.4% (S&P1500 Energy Index, S15ENRS).(1)

The clean energy sector is one of many dichotomies.  Enthusiasm for decarbonization is high with corporations and institutions investing aggressively in projects and technologies.  Yet profitability is elusive and aggregate clean energy stock performance has been dismal.  For every step forward, such as the Inflation Reduction Act, there is a step back, such as the recent technology problems with Siemens Energy wind turbines.  

The concept of clean energy and decarbonization is simple.  Implementation is difficult.  We suspect it will be this way for the next few years, creating a myriad of alpha opportunities around an upward sloping adoption curve.  

A few specific items worth mentioning:

* Tesla and EV companies - Tesla remains a fascinating case study of disruption, innovation and animal spirits.  The company continued its price cuts during Q2, admittedly at the expense of gross margins.  However, the strategy has worked in terms of demand, resulting in record (and above consensus) Q2 deliveries.  Tesla also benefited from the mega cap tech rally, at one point enjoying 13 consecutive days of positive stock price performance.  It is yet to be seen whether the stock rally can be sustained through Q2 earnings (where the gross margin piper will have to be paid).  We have high confidence in TSLA as one of the winners in the ongoing EV war.  Incumbent automakers such as Ford, GM, Toyota, etc. will also survive (and eventually thrive) in an increasingly electric world.  The prospects for the other EV newcomers are much more cloudy - many newcomers are already floundering and most will fail.  

* Contracts/partners are king, execution is queen - Clean energy is a world where technology is changing quickly and business models are constantly evolving.  The sector is rapidly evolving beyond the honeymoon phase where any decarbonization angle could find a SPAC or easy money.  Institutional capital and public company investors are increasingly looking to anchor customers and strategic partners for validation.  A project/technology with a major industrial partner or anchor buyer can quickly move from a struggling pie-in-the-sky idea to an investible story.  We’ve seen this with projects/technologies in hydrogen, ammonia, EVs, methane capture, carbon capture, offshore wind, extraction of enabling commodities and many others as they move from Series A to Series B to Series C+ to project finance and eventually a sale or IPO.  But the involvement of a “smart partner” and/or contracted offtake is not enough.  The technology must deliver, the facilities must be constructed on time and on budget, the volumes must be delivered…and eventually money must be made.  Stumble and the punishment is swift and severe.  Siemens Energy fell over 35% in one day as the company acknowledged windmill turbine problems that will require costly repairs.  Enviva fell 80%+ from its 2022 highs as the company’s wood pellet green benefits were challenged and customer contracts appeared to be less binding than expected.  The game is getting smarter and tougher.  

No change to our thematic views which are driven by the combination of supply/demand dynamics, the status of technology development and stock/sector valuation.  On the long side: Energy storage, carbon capture, enabling commodities, decarbonization equipment and services, special situations.  On the avoid/short side: Electric vehicle industry, hydrogen, wind & solar.

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