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While the E&Ps have strongly bounced back over the past two weeks, in part due to the market shift towards Value over Growth and Momentum, the sector is still -34% YTD vs. the S&P500 and increasingly has the feeling of being left for dead. Whether due to fear over oil prices heading below $50/bbl on weakening demand/plentiful supply, the rise of renewables, Energy shrinking to <5% of the S&P500 pie, or historical sector value destruction, we see the market’s perception of the E&Ps more about concern than opportunity. There’s still plenty for the E&Ps to prove, but with the sector pricing in $45/bbl WTI and trading at the widest margin (6.5x) to the S&P500 on NTM EV/EBITDA going back to 2001, we see good value in the E&Ps and believe this short rally could wake up the market to an improving outlook.
While natural gas storage levels have remained below the 5-year average YTD, the deficit has been steadily declining over the past few months with last week’s injection putting total stocks to less than 100Bcf below the historical trendline. Total natural gas storage now sits at only a 3% deficit versus the 5-year average compared to the 30% deficit seen at the beginning of injection season, with all regions in the L48 now within 10% of their historical averages and the Midwest region even exceeding its norm for this point in the year. The return towards normal storage has largely been due to the roughly 4Bcfpd supply growth since YE18, along with higher injections in the South-Central and Pacific regions that were drawn down heavily in February & March due to a prolonged winter season. Despite the narrowing storage gap, which would normally suggest downward pressure on price, near-term pricing has strengthened, likely as a result of warmer weather across half of the U.S. and short covering. This likely means we’re in for another volatile 4Q pricing period, just as we saw in 2018, but we’d note that the 2020/21 curves continue to remain around $2.50/mmbtu, so the forward outlook has remained relatively unchanged.
Inside this week we have two features, the first is we look at the S&P 500 Energy Index vs. the ISM Index as it broke 50 this week. FYI, Energy was the best performing sector this week. Second, we sat down with HES this week for a catch up, with notes inside.
August marked more of the same 2019 blues for the E&Ps, with our benchmark Index falling a steep 17.3% last month. Driving the poor performance were global economic fears, WTI/Brent prices moving lower by 6%/9%, and operational missteps during 2Q earnings that caused outsized moves in multiple equities. Given the magnitude of the selloff with crude oil prices still near $55/bbl, investors remain cautiously optimistic, with a small majority expecting the sector to both end higher by YE19 and outperform the S&P 500 (see our 8/26 Survey note). We see the same potential, but the execution bar remains high and the follow through on FCF generation remains key. EOG and FANG remain top picks.
After trading as low as negative $8/mmbtu earlier this year, Waha pricing has recovered with the startup of the Gulf Coast Express pipeline. In August, Waha Basis averaged -$1.24/mmbtu below Henry Hub, a $0.60/mmbtu month over month improvement, and the trend has continued in early September with spot prices now only $0.65-.70/mmbtu back from Henry Hub driven in part by a Texas heat wave. The outlook for the remainder of 2019 has improved as well, with Dec. 2019 pricing just touching $2/mmbtu again, putting the differential near -$0.50/mmbtu. While the 2020 curve currently does fall back to a -$1/mmbtu differential, the short-term boost in natural gas prices should provide a tailwind for heavier natural gas Permian producers (XEC, CDEV, LPI) along with APA’s Alpine High volumes. Additionally, the impact of the 2Bcfpd Permian Highway Pipeline (2H20) and the 2Bcfpd Whistler pipeline (2H21) have improved the outlook for 2021 differentials to -$0.56/mmbtu. See page 5 for Waha historical basis prices and forward curve.
It’s back to the grind this week and in preparation for the upcoming conference season, inside this weekend we provide a list of sector and company level questions across our coverage universe. We touch on the key issues around growth rates, return of capital, M&A, and asset specific questions/catalysts that can drive sector and stock performance through the rest of the year.
Across three energy sub-sectors, we encounter almost no investors that are bullish crude oil prices for 2020. Sliding GDP forecasts, currency headwinds, trade war impacts, and non-OPEC supply fears have increasingly stressed expectations. However, the two components that led us to be constructive on crude heading into the year – decelerating US production growth and IMO 2020-driven low sulfur demand pull – remain intact. We examine both in this note.
Mexico Announces Natural Gas Pipeline Contract Renegotiations. Earlier this week, news sources reported that Mexico has reached a deal with pipeline operators on natural gas delivery contracts. As part of the renegotiations the contracts fees will now be held flat rather than increase annually, and the terms of the contract were also extended. The deal focused on seven natural gas pipelines run by four different operators including Canada’s TC Energy, Mexico’s Carso Energy and Fermaca, and Ienova, although these renegotiations did not include Fermaca which operates two of the seven pipelines. With the renegotiations now complete, several pipelines including the 2.6Bcfpd Sur de Texas-Tuxpan pipeline may begin operations over the next few weeks. The Sur de Texas-Tuxpan pipeline has been mechanically complete since June but the CFE has held off formally putting the pipeline into service until the contract renegotiations were complete. We view the deal as a positive sign for natural gas pipeline operators in Mexico and it should help to increase natural gas deliveries across the county. This is also a positive for Permian and South TX producers for export volumes, as supply to Mexico has historically disappointed versus expectations due to delays. In our model, we are forecasting almost 4Bcfpd of incremental exports to Mexico by 2025, bringing our average 2025 export number close to 9.7Bcfpd. Our upside case assumes the full incremental 4.5Bcfpd of capacity comes online on time and is fully utilized, while our downside case assumes further delays and lower utilization.
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