2018 was an important year for DVN in pursuit of its “Vision 2020” corporate transition plan as the company shed its EnLink position and multiple non-core assets. Though the financial benefits of a separation were clear – reduced corporate debt, significant G&A savings, and a new $4Bn share buyback program – there is still more work to be done and the forward outlook took a step back following the most recent STACK update. We like the path DVN is on, but we believe a more aggressive divestment program may be needed to get the shares to outperform.
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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
As an unhedged producer, CDEV was one of the bigger beneficiaries of rising crude oil prices in 2018, though the year didn’t quite play out as we thought as concerns over Permian takeaway held the stock in check. Despite a management team that has been executing well on a rapid growth profile, oil volume beats are getting harder to come by at CDEV while the 2021 return of capital profile has little room to be brought forward. In our view, beating expectations is a key driver of stock performance for early-stage producers but with upside to our forecasts limited and valuation back to a 1.5x turn premium to peers on 2020 EV/EBITDAX, we move to Peer Perform.
We were previously cautious at MUR as we saw an asset base too widespread and challenged from a capital allocation process, but progress is being made on both fronts to improve the forward outlook. The just closed Gulf of Mexico JV supports an increased concentration of high-margin production and free cash flow to be directed towards the Eagle Ford with the potential for more sales in the International portfolio to act further catalysts. We liked the shake-up, capital return to shareholder yield, and feel the improved profile no longer warrants a negative view. Upgrade to Peer Perform.
After fighting through potential legislative challenges in Colorado, PDCE is looking forward to turning the page on 2018. However, we still see some challenges in front for PDCE that give us caution on the forward outlook, including midstream constraints in the DJ that limit upside to the multi-year growth plans and a Delaware acreage footprint that needs to grow if development plans accelerate. We like that PDCE has a path to free cash flow in 2020 and the balance sheet remains in good shape, but with some risks in front, Colorado legislative risk now an unknown, and our preference towards larger scale developers with greater oil exposure, we move to Underperform.
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.
We may have finished on a strong note following the OPEC/NOPEC decision on Friday (12/7/18) to reduce supply by 1.2mmbpd, but this was a challenging week all around. For the week, crude oil was +3%, our E&P Index was -3.1%, and the S&P500 was -4.6%.
Natural gas flaring in the Permian Basin reached an all-time high in 3Q18 as overall production continues to rise without any incremental export capacity. According to Rystad, natural gas flaring in the Permian was 407mmcfpd in 3Q18, a 16% increase from 2Q18 and an 84% yoy increase 3Q17, with the impact of this significantly reducing local pricing (spot is currently <$1.50/mmbtu and has traded below $0.50/mmbtu recently). The trend is also one we expect to continue into 2019 until pipeline buildouts in the region begin to alleviate the takeaway constraints. This was a key change in our most recent natural gas supply/demand model update as we assume the Permian will show flat volume growth from 4Q18-4Q19 when Gulf Coast Express comes online. While this flat may be a conservative outcome, the increased flaring shows that more capacity is needed and that 2Bcfpd of annual capacity additions may not be enough to alleviate constraints going forward. See page 3 for volumes of natural gas flared in the Permian since 2011 and our forecast for Permian production through 2020 versus the upcoming growth in the region’s takeaway capacity.
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.
As withdrawal season begins with total L48 storage over 700Bcf below the five-year average, we looked at the individual regions to see where there might be the most market tightness which could lead to more volatile pricing. Currently, all five storage regions (East, Midwest, Pacific, South Central, Mountain) are lower than the bottom of the region’s respective five-year average range for storage levels, although it’s the South-Central region, which encompasses the Permian, Eagle Ford, Anadarko, Arkoma, and Haynesville basins, that shows the greatest deficit of 337Bcf (27%) below the five year average. Regional storage in the South-Central region now sits at the lowest level since 2005, when Hurricane Katrina and Rita damaged infrastructure in the region. This should benefit the Haynesville producers the most along with the Northeast producers that are now better able to access this market, but the Permian still doesn’t have the capacity to benefit and that’s showing up in spot pricing that’s <$0.30/mmbtu today (11/28/18). See page 3 for the breakdown of regional natural gas storage levels.
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