Well, we’re only two weeks in but its been a good start to the year for the E&Ps with our Index +8% this week, outperforming the S&P500 by 530bps as WTI/Brent continued to move higher, finishing at $51/$60/Bbl. We know there is doubt about sustained outperformance after the head fakes of the past three years, but we believe crude oil continues to see strength and the producers so far, are adjusting well to lower prices, keeping our outlook positive on the group.
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Feels strange writing this after the last three months but our E&P Index was +9% vs. the S&P500 +2%, and WTI +6%. Even more strange was that after outperforming Wednesday and Thursday, our E&P Index outperformed again on Friday when the rest of the market was up 3%. Knowing how volatile the market has been over the past few months, we’re still on our toes, but this week was encouraging.
For our chart this week, we look to Materials and Mining, two other commodity sectors to see how performance has compared against the backdrop of waning global demand growth concerns. While supply and demand fundamentals are different for each commodity, we found it interesting that the ETFs of each of the sectors has generally trended in the same direction, though Materials, lead by a 21% DowDuPoint weighting and is mostly chemical oriented, has performed the best over the past two months.
For the week, our E&P Index ended down 14% vs. the S&P500 down 7% and WTI down 11%. It was tough to look at the screen each day and have a sea of red, but it was an important week for announcements, both on the individual stock and macro level. One of those was from the Fed raising rates and suggesting more increases could come with the impact pushing the US Dollar lower by 0.5% this week. We’ve thought that a lower dollar would help support crude oil as it would allow for emerging markets to purchase the commodity at lower prices, though it’s become clear that any conversation on demand is all about the downside risks. Still, if the trend holds, we see it as a positive driver for crude oil.
The holiday period is now upon us, though before our minds started wandering off, we were able to get in front of many investors and companies, getting some feedback on the Energy sector, crude oil, and stock ideas. For those unable to listen in, Sam, Blake and I hosted a webcast covering our top ideas, commodity views, key themes, and the impact of electric vehicles on crude oil demand.
In the shifting E&P paradigm towards balancing growth with free cash flow generation, we see COP as a structural winner with the ability to compete against both the Integrateds on a global scale and North American Independents developing core unconventional assets. The stock has outperformed in 2018, but we see this strength continuing into 2019, particularly as COP offers the core of what we believe will lead to outperformance in 2019 – Brent exposure, a strong balance sheet, and growing return of capital to shareholders
While the underlying fundamentals of the sector have improved over the past two years, 2018 has been another year of underperformance vs. the S&P500 for the E&Ps. We think the sector is set to recover though as crude oil bounces back to $60/bbl, but from there, we think the Large Cap E&Ps will emerge as the subgroup to own driven by their broader leverage to Brent, stronger balance sheets, and ability to generate FCF at lower prices. Top picks are FANG and EOG.
It’s a busy week for the markets, the Energy patch, and crude oil direction as attention turns from the G-20 Summit to the OPEC meeting on Thursday with both events helping to shape the 2019 outlook.
While there are multiple ways to group E&Ps, increasingly our focus has been on separating producers based on balance sheets amid uncertainty over crude oil price direction. Although multiple factors have played into recent stock performance, one the biggest gaps has been between our strong vs. weak balance sheet index that’s widened out to a 20% spread since Oct 3rd. We would anticipate this to narrow with resolution to global trade tension and an OPEC supply reduction agreement, but our view is that balance sheet position will increasingly play a factor in stock performance that was left off the priority list two months back.
Another challenging week for the market, crude oil, and the Energy sector. WTI is now approaching $50/bbl and Brent is following suit below the $60/bbl mark, taking our E&P Index down 4.4% and underperforming the S&P500 by 60bps. While looking at the sea of red each day has been a challenge, trading has been rationale with the large caps outperforming the SMID caps by almost 4%, putting the two week collective outperformance at 10%. We’d note too that the Large Caps have also outperformed the S&P500 over the last two weeks by 180bps despite the crude oil free fall. That, at the very least, is an encouraging sign.
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