Energy Stocks Still Have Gas in the Tank

Oil and natural gas are hot, and so are America’s energy reserves. But investors, whether they’ve been around or just thinking about getting in now, can be wary of getting burned.

January-March this year was the industry’s best quarter since 1970, according to BofA Global Research. While the S&P 500 is down about 13% so far, the energy sector is up 49%. That comes after a year when energy stocks beat the broader index by 21 percentage points.

Passive index investors have not received a significant increase since the energy shine. Energy accounted for just 2.7% of the S&P 500 at the end of last year, a far cry from the 11% the sector commanded a decade ago. And, according to BofA, active funds were significantly shorted into the energy sector in the first quarter. Today, the share is about 4.5%.

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Investors tempted by energy returns may wonder if the rally has headed in the right direction. After all, energy is a cyclical field: Exciting highs tend to be followed by equally narrow lows. Periods of high prices lead to more drilling or reduced demand, until eventually commodity prices fall.

How far have we come into this cycle? It’s been more than two years since the last bottom (right around the time oil futures prices plummeted) and the market value of the industry has more than tripled since. The past two major cycles seem to imply that the good times are not yet complete: The last cycle — seen between the years 2014 and 2014 — lasted about five years and four months, while the journey to its climax seen in 2008 lasted a little longer than that (five more months). It should be noted that the time from bottom to top has only shortened, partly due to US shale production, where the fracturing process has caused oil and gas to be extracted quickly. The most recent cycle, which led to the top in 2018, was not particularly dramatic or lengthy, taking about two and a half years.

But this time it might be different. What’s remarkable is how America’s oil companies plan to conduct themselves with their drilling in a disciplined way – and not just to atone for past outrageous behavior. While equipment and labor shortages characterize almost every energy cycle, Dan Pickering, founder and chief investment officer of Pickering Energy Partners, notes that he has never seen a degree of scarcity. as rare as it is today.

The US Energy Information Administration estimates that crude oil production in the US could increase by 800,000 bpd in 2022 and then another 900,000 bpd in 2023. While that seems like a lot, it is. at a slower pace than in pre-pandemic years. In 2018 and 2019, the US increased oil production by 1.6 million and 1.3 million bpd, respectively. Another factor affecting prices is a potential European ban on Russian oil imports, not all of which will find their way to countries like India and China. Before Russia invaded Ukraine, the European Union was importing about 4 million barrels of crude oil and refined products from Russia every day.

SPDR Fund for the Energy Sector,

A widely watched ETF that tracks the energy sector in the S&P 500, it is still 17% below the 2014 peak and 8% below the 2008 peak. The enterprise value of the shares in the fund is about twice as much. 5.9x earnings before interest, taxes, depreciation and amortization over the next 12 months — nearly a fifth less than the 10-year average. And the industry’s valuation based on that metric is still 52% below the S&P 500 compared to the 34% discount the sector has experienced on average over the past decade.

While a cyclical industry is always a risky bet, today’s energy industry is – by some measures – the most investor-friendly for a while.

As Europe races to phase out Russian energy, US natural gas producers are struggling to meet rising demand and prices. Factors including inclement weather and a need for equipment have created a knot in the middle of the war in Ukraine. Illustration: Laura Kammermann and Sharon Shi

Write letter for Jinjoo Lee at jinjoo.lee@wsj.com

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Appears in print May 9, 2022.

https://www.wsj.com/articles/energy-stocks-still-have-gas-in-the-tank-11652018401?mod=rss_markets_main Energy Stocks Still Have Gas in the Tank

Edmund DeMarche

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