With the winter season now in full swing, and a snowstorm looking set to bear down on the Northeast in time for this weekend, we thought that now would be a good opportunity to look at where we stand 2.5 months into the natural gas storage withdrawal season. Since the beginning of withdrawal season on November 1st, we estimate that 529Bcf has been drawn from storage, down almost 48% Y/Y from the 1,003Bcf of natural gas drawn over the same time period last year and down 25% from the five-year average of 703Bcf withdrawn over the same seasonal period. As a result of the slower-than-average withdrawal pace, the current natural gas storage level has narrowed the gap to the five-year average storage level, and now sits at the lowest deficit that it has over the prior twelve months. We view this as a relatively bearish indicator given that the gap between current storage and the five-year average was one point that commodity bulls had pointed to at the start of the season. Going forward, more wintry weather has the potential to reverse the dynamic, and if we assume that the storage withdrawals for the remainder of this winter occur at a similar pace as the chilly 2017-2018 winter season, we estimate that we would exit withdrawal season with 1,165Bcf of natural gas in storage. This level would be 14% below the exit level last year, and 31% below the five-year average exit level.
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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.
It took three years, but 2018 saw the return of domestic upstream M&A transaction value back to the last upcycle swing of 2011-2014. A lot of this was driven by an improving commodity backdrop, but sector fundamentals also improved and looking forward, we continue to see the need for sector consolidation and continue to see A&D as a positive driver of stock performance.
The two main drivers of domestic natural gas demand growth remain LNG and pipeline exports and while the former has come in greater than expectations, the latter has lagged. Mostly likely due to infrastructure delays south of the border, the annual growth rate of 0.4-0.5Bcfpd over the 2017-18 has slowed from 0.8-0.9Bcfpd seen in 2015-16 time period, but our base outlook calls for a rapid reacceleration though 2019 and 2020. There will be plenty of swings in export volumes as seasonal factors come into play, but the trend should start increasing through 2019 with our outlook calling for an average of 5.9Bcfpd this year and 7.1Bcfpd in 2020. Recently hitting the 5.1Bcfpd after a downswing in December, we’ll be looking to see how volumes flow over the next few months to determine how aggressive our 1.3Bcfpd growth assumption for 2019 might be and if we’ll have to revise our estimates lower as we’ve done the past two years. If we do, it means more downward pressure on domestic pricing and potentially pushes out the recovery of WAHA pricing that’s expected over the course of the next 12 months. See pages 3-4 for the weekly Mexico volume data and our forecasts.
This Wednesday (1/9/2019) at 11am we’re launching our bi-weekly Energy webcast series and we’re kicking it off with our 2019 conviction ideas and drivers for why we see a return to $80/bbl Brent in 2020. Within, we outline our high level Energy views and portfolio construct. Register here to have access to every webcast.
This morning (01/07/19), in a written letter to the board of QEP, shareholder Elliott Management announced a proposal to acquire 100% of outstanding shares for $8.75/sh in cash. Despite announcing the Williston and Haynesville transactions, the stock hasn’t been able to close the valuation gap to peers that management and Elliott thought would occur when the divestiture plan was announced in February 2018, with the pro-forma Permian-only QEP still trading 1-2x below peers on 2020 EV/EBITDAX. With execution over a longer time horizon the other possible option to re-rate the stock higher, this offer looks to be the fastest way to narrow the gap and will push the board and Tim Cutt, the incoming CEO starting 1/15/19, to look hard at the offer. With the stock currently trading at $8.60/sh post the announcement, we remain Peer Perform rated with further upside possible if other offers come in. We outline our Permian only model and valuation inside.
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.
Quicker than it went up, natural gas came back down to end 2018 back where it started with front month now just below the 2.5-year average of $3/mmbtu. While volatility peaked over the last three months, it’s been amazing to see the tight band natural gas has traded in outside of this latest round trip, a result of short-cycle supply meeting up with long-cycle demand to balance the market, in our view. For the next few years though, we believe the equilibrium point is moving below the $3/mmbtu level, as the supply curve continues to move lower, meaning the U.S. can deliver the visible demand growth projected at a lower price. Periods of volatility will still exist around weather, which has clearly been exacerbated over the last three months due to below normal storage, but we continue to see a well-supplied market unless the Appalachia producers slow down or cold weather returns (we have the 6-10 day/8-14 day NOAA outlooks on page 3 showing the near-term warm weather to come). Our outlook remains $2.75/mmbtu in 2019 and $2.50/mmbtu with flat Permian natural gas volumes from 4Q18-3Q19.
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.
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