October 2023 – Commentary from Dan Pickering

The drums of consolidation are beating louder.
Underwhelming – October 2023 saw Diversified Energy (S&P 1500 Energy, S15ENRS) fall -5.5% with subsector performance as follows - Midstream +0.4% (AMZ), Upstream/E&P -1.8% (XOP), Oilfield Services -6.0% (OIH), and Clean Energy -11.0% (ICLN).  The broader market also fell (S&P500 -2.1%, Nasdaq Composite -2.8%).  YTD the energy benchmark is +0.7% against broad market indices +10.7% S&P500 and +23.6% Nasdaq. WTI oil fell -10.8% during October, finishing at ~$81.00/bbl.  Natural gas gained +22.1% (~$3.60/mcf). (1)

Oil markets generally yawned at Middle East tensions during October.  After an early spike, the lack of escalation beyond Israel/Gaza resulted in a “heavy” crude market that wound up -11% for the month.  We believe WTI remains one geopolitical mistake from $100++/bbl.  However, it is also clear that most world players are pushing aggressively to contain the situation (and from every qualitative and quantitative perspective, we clearly hope this happens).  Meanwhile, expectations and fears around the economy oscillate faster than a 3rd-grader hopped up on Halloween candy.  Our $80/bbl long-term WTI forecast is unchanged, and we are particularly happy we don’t (haven’t, won’t and never will) try to estimate monthly or quarterly.

Looking longer-term, the International Energy Agency released the World Energy Outlook 2023.  Amidst a plethora of forecasts, we were struck by the overarching view that all hydrocarbons (coal, oil, natural gas) would hit peak demand by 2030.  China’s coal usage is forecast to peak in 2024 – someone should alert the Chinese, who started construction of 35+GW of coal plants in 2023 and permitted another 40+GW.  Natural gas and oil were viewed to plateau around current levels through 2050 in the Stated Policy Scenario.  This implies that all incremental demand going forward will be supplied by renewable/non-hydrocarbon energy sources.  This seems impractical at best and borderline laughable at worst.  Somewhere along the way, the IEA has shifted from an analytical framework to advocacy approach, with hard-hitting, clear-thinking data as the victim.  We like to consume the IEA’s data but are increasingly ignoring its forecasts.

October was a big, big merger month.  Exxon and Pioneer Resources announced a deal on October 11th after rumors began swirling the prior week.  Chevron combining with Hess hit on Monday, October 23rd. Together, these two deals represent over $100B of investment by the two supermajors in high-quality oil and gas assets/inventory.  Exxon added short-cycle shale resources in the Permian, while Chevron added international barrels in Guyana. In our view, both deals highlight management and Board confidence in the long-term future of oil and gas.  By default, both deals indicate management and Board confidence that we are relatively early in the ongoing energy upcycle.  And yet the stock market refuses to deliver any respect – where we define respect as stock performance better than the overall market.  Some stats:
  1. Exxon stock closed at ~$109/share on 10/5/23, the night before the Pioneer deal rumor surfaced in the Wall Street Journal.  From that point until its Q3 earnings announcement (the morning of 10/27/23), Exxon fell -1.3% compared to the S&P500’s loss of -2.8% and oil’s slight gain (+1.1% to ~$83.20/bbl).  Following earnings, Exxon gave up relative gains and finished the 10/5-10/31 time period -2.9%, lagging the S&P500 by ~140bps, lagging the independent E&P’s +6.0% and materially underperforming the +3.4% of the European majors that are considered to be sitting out the consolidation game. Oil was -1.6% over the cumulative period.
  2. Chevron stock closed at $167/share on 10/20/23, the last closing price before the Hess deal was announced on the morning of 10/23/23.  From that point until its Q3 earnings announcement (the morning of 10/27/23), Chevron fell -7.2% compared to the S&P500’s loss of -2.1% and oil’s -6.2% loss.  Following earnings, Chevron dropped another 500+bps and finished the 10/23-10/31 period -12.7%, lagging the S&P500 by ~1200bps, lagging the independent E&Ps -3.3% and the European’s pullback of -3.1%.  Oil fell -8.7% over the cumulative period.
Neither Exxon nor Chevron did themselves any favor with Q3 results, which missed expectations and added insult to injury for shareholders who were already absorbing arbitrage-related hits from the all-stock transactions.  Although an inauspicious start, we suspect the time in the doghouse should be relatively short.  It is likely that investors will look back in a few years and see deals that delivered good assets at a reasonable price and were decently timed.

In the meantime, the drums of consolidation are beating louder.  Dominoes are falling with scale and investor relevance as the objective.  A Devon and Marathon Oil merger has surfaced.  Chesapeake Energy plus Southwestern Energy has also been rumored.  Quality asset inventory is being removed from the market.  The high-profile nature of October’s deals has every E&P company management and Board reviewing their own game plan.  Any company targeting a Permian acquisition in the next 2-3 years is likely accelerating the timing to make sure there are still quality assets left to acquire.  Midstream and OFS companies must be asking themselves if they need to be bigger to accommodate bigger customers.  We used the phrase “buckle up” earlier this year, so now must settle for “stay buckled up”…further deals are ahead.

A quick note on clean energy.  While the Inflation Reduction Act and the ongoing global decarbonization push has created a huge opportunity in the sector, it has been an unmitigated disaster for public company investors.  The S&P Global Clean Energy Index (SPGTCED) is -34% YTD and ~-60% from its all-time highs in early 2021.  The same story for the iShares Global Clean Energy ETF (ICLN) at -34% YTD.  And the Invesco Wilderhill Clean Energy ETF at -33% YTD.  And these are investment vehicles that invest in the largest and most-established clean energy plays.  The sector is littered with smaller cap and technology-oriented names that are down -50% YTD and off 80%+ from their highs.  Wind projects are being written down across the globe, solar equipment is in massive oversupply, and profitability expectations are being pushed to the right.  Additionally, interest rates are rising, decreasing the value of hockey stick financial projections.  In this carnage will be opportunity.  We’ve seen this before with oil and gas stocks.  They are all left for dead, but many of those that survive ultimately become big winners.  The same will be true in clean energy.  We are starting to sift through the rubble.  It is still early, therefore it is primarily an investment of time, for now.  But eventually it will be an investment of dollars with expectations of venture capital-type returns.

(1) Source: Bloomberg