Upgrading To Outperform. Alongside our sector move to Market Weight from Underweight, we’re upgrading COG to Outperform from Peer Perform. We’ve been on the sidelines at COG looking for a better entry point and waiting for expectations to reset around a $2.50/mmbtu price environment. With the stock now -20% over the last three months, Consensus coming down to 5% 2020/21 volume growth, and our $27 PT intact, we see an improved risk/reward and opportunity to own one of the best low-cost asset bases and steady FCF profiles amongst E&Ps.
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Upgrading to Peer Perform. Alongside our sector move to Market Weight from Underweight, we’re upgrading SWN to Peer Perform from Underperform. While SWN has maintained its YTD outperformance gap vs. AR and RRC, the stock is -53% since our mid-April 2019 downgrade, which is the key driver of our upgrade. Challenges lie ahead, particularly getting to a position of generating sustainable FCF, but corporate and well cost reduction initiatives have come through with more capital efficiency also possible, and the balance sheet can survive $2.50 pricing, so we see a risk/reward is more balanced.
Moving SMID Natural Gas Sector To Market Weight. With our natural gas price outlook remaining $2.50/mmbtu through 2021, the sub-sector down 20% since our mid-Summer update, -36% YTD, and for some producers >90% off all-time highs, risk/reward is more balanced, and we move the group to Market Weight from Underweight. There are still challenges facing the natural gas producers in a $2.50 environment, but Consensus estimates are now more aligned around this price outlook, asset values remain below Strip pricing, and we see flat $2 pricing as lower probability scenario over the next 6-12 months given the supply response already occurring at $2.50.
Wolfe Research Senior Analysts Steve Fleishman (Utilities & Midstream), Scott Group (Transports), Nigel Coe (Industrials), and Josh Silverstein (Oil & Gas Exploration & Production) hosted a webcast to go over their regional power outlook, gas additions vs. coal retirements, the renewables explosion and latest on nukes, implications for the rails, the impact on natural gas demand, the impact on industrials, and stock implications.
The Wolfe Utilities and Power team updated its 5-year outlook for U.S. power supply and we again incorporate the data into our macro supply/demand model. The key takeaway from the update is all about the accelerating trend of renewable capacity additions at the expense of other fuel sources, with natural gas additions decelerating following a long period of being the replacement for coal. After +5Bcfpd of growth from 2017-2019, based on the current slate of projects in development, we forecast only 1.2-1.4Bcf/d of new capacity growth in 2023 over 2019 or less than 0.3Bcf/d per year.
It was another volatile week for the E&Ps this week as sector performance got off to a good start, faded towards the middle, and then rallied back on Friday to finish +6.9% for the week vs. the S&P500 +1.0% and WTI -2.8%. Performance between the sub groups continues to be split, with the rally in gas names continuing for a second week.
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.
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.
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