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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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.
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.
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.
Mired in a crude oil slump, investors have been looking for how producers would react heading into 2019 and we got two strong messages from Permian leadership over the past week. We took PXD’s buyback as a clue that spending would slow, and FANG’s message today is more evidence that balance sheet strength, asset base preservation, and increasing capital returns to shareholders are being prioritized over growth. Not all producers are in FANG’s position to deliver 25+% growth alongside all this, but we hope the trend continues (we’re 3 out of 4 reports this month showing lower spending vs. consensus) as this would support the regime change underway for the E&Ps.
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.
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.
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
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