Energy Sector

[lessthaniv]

A good read.

 

https://arjunmurti.substack.com/p/where-are-we-in-the-energy-cycle

 

 

[Eng12345]

8 hours ago, lessthaniv said:

A good read.

 

https://arjunmurti.substack.com/p/where-are-we-in-the-energy-cycle

 

 

Great read, thank you.

 

At this point I’d like to hear the bear case for energy over the next 3-5 years…

 

Venezuala?

Iran? 
Giant global recession?

Electric Cars?

Sun and wind can power everything?

Perpetual motion machines?

[Dinar]

I read somewhere that Europe could cut its nat gas consumption by 25% if it lowered thermostats in winter by 3 degrees Celsius and raised them as much in the summer.  I do not know whether that is true or not, but if true, there is a lot of demand destruction that can happen world wide if people accept less comfort.  Even 10% would be a gigantic change.

[Sweet]

Combined with turning radiators off, and not using electricity at peak times.  I read that one company was paying their customers to not use electricity late at night to reduce peak load.

[Sweet]

9 hours ago, Eng12345 said:

Great read, thank you.

 

At this point I’d like to hear the bear case for energy over the next 3-5 years…

 

Venezuala?

Iran? 
Giant global recession?

Electric Cars?

Sun and wind can power everything?

Perpetual motion machines?

The bear case, if you can call it that, is the world has plenty of oil, either through production or inventory buffer.  Some of the bullish narratives do appear over done.

[dealraker]

When?  My view still and I've used it before...but I'm a dumbed down model guy while most aren't: 

 

• S&P 500 WEIGHT: Structural Energy upcycles typically end when Energy’s S&P weighting is in the low-to-mid teens. Currently, Energy has merely rallied to just over 5% of the S&P 500 from its 2% October 2020 low. While a lot depends on the outlook for other sectors, energy tends to "punch its earnings weight" in the S&P 500 arguing for a 10%+ S&P market cap weighting today.

• RUSSEL GROWTH WEIGHT: Structural Energy upcycles end when Energy’s Russell Growth weight is noticeable, which I might characterize as over 10%. Currently, energy is just 2% of Russell Growth, up modestly from the circa 1% it was for much of the 2016-2021 period. To be clear, traditional energy is not a growth sector. Still, during the up portion of the structural cycle, it has historically reached a 10%+ weighting in the Russell Growth Index.

[Sweet]

What if it never returns to those averages @dealraker ?

 

Many view fossil fuels as a dying industry, and with the rise of environmental investing, a lot less are interested in it.

 

I don’t agree with any of that, but others do, and that is a headwind.

[dealraker]

8 minutes ago, Sweet said:

What if it never returns to those averages @dealraker ?

 

Many view fossil fuels as a dying industry, and with the rise of environmental investing, a lot less are interested in it.

 

I don’t agree with any of that, but others do, and that is a headwind.

Of course it is a dying industry...I'm guessing Mr. Buffett knows well.  But contrary to popular belief maybe, just maybe, the electric car would have progressed without psycho man and that industry too will return to the norm whatever that may be.  Tobacco headwinds and all the rest...and even the eyeball industry headwind which includes basically every single stock obsessed about in the world while one or so businesses have a market cap that mandates perfection of moat defense.  

 

Limits everywhere along with expertise of prediction.   Me?  I just play the game in, as I've said, the dumbed down mode.  "Berkshire" is on this board's name and there's somewhat of a connection, a rather large one, to this industry.  

[Spekulatius]

The energy industry self liquidates by paying out dividends and buying back stock, That’s one reason why I don’t see it returning to its former weight in the stock market indices. Nothing wrong with this and it doesn’t mean that returns can’t be good going forward in this sector.

 

As for the bear case, it’s demand destruction (EV transition, China pivoting away from a Capex driven to consumer driven economy) and perhaps OPEC or some OPEC countries doing something unexpected on the demand side. 
EV transition just shifts energy demand away from crude to other sources , some of which are fossil. I think NG might keep growing longer than crude demand for example.

[Sweet]

^ China is for sure a bear case too.

 

Overall though, I do think higher for longer mantra is about right.

 

Will energy companies reprice in at higher multiples, yes, but I think probably not as much as people might expect.

 

I do think energy has a much longer runway than the mainstream view, Larry Fink says 70 years - not sure about that long but certainly multiple decades.

Edited December 4, 2022 by Sweet

[SharperDingaan]

The bear case is largely two-fold (1) ESG is repealed as just too difficult to do, market floods with new supply (2) Russia/China successfully pull off an entirely alternative supply/demand market for sanctioned o/g outside of 'western' control - linked to the conventional market via OPEC membership. Both are possible high impact events, but with a low probability of success, net of western interference - simply because Infrastructure cannot be used/repaired without western complicity.

 

Three big buyers (China, Asia, India), three big sellers (Russia, Iran, Opec+), settlement in Yuan vs USD, and processed via China's financial system. Uninsured ships and cargo's, loading facility/ship/cargo security/sinkings's just another cost of doing business, whistle for pollution cost restitution. No different to driving drunk, and uninsured, down the highway; not good, but an everyday occurrence in much of NA.

 

Most would argue that of the two, ESG repeal is the easier to implement. To gage probability of success, think of how difficult it would be to achieve that ... if you do NOT live in the world's o/g basins! 

 

SD

 

Edited December 4, 2022 by SharperDingaan

[Mephistopheles]

3 hours ago, SharperDingaan said:

The bear case is largely two-fold (1) ESG is repealed as just too difficult to do, market floods with new supply (2) Russia/China successfully pull off an entirely alternative supply/demand market for sanctioned o/g outside of 'western' control - linked to the conventional market via OPEC membership. Both are possible high impact events, but with a low probability of success, net of western interference - simply because Infrastructure cannot be used/repaired without western complicity.

 

Three big buyers (China, Asia, India), three big sellers (Russia, Iran, Opec+), settlement in Yuan vs USD, and processed via China's financial system. Uninsured ships and cargo's, loading facility/ship/cargo security/sinkings's just another cost of doing business, whistle for pollution cost restitution. No different to driving drunk, and uninsured, down the highway; not good, but an everyday occurrence in much of NA.

 

Most would argue that of the two, ESG repeal is the easier to implement. To gage probability of success, think of how difficult it would be to achieve that ... if you do NOT live in the world's o/g basins! 

 

SD

 

 

In the 2nd scenario, is that really a bear case for oil? The supply chains will be re-routed (similar to what's happening already), but this is unrelated to the demand side. Even if settled in Yuan, presumably the ROW prices oil in dollars still.

[SharperDingaan]

2 hours ago, Mephistopheles said:

 

In the 2nd scenario, is that really a bear case for oil? The supply chains will be re-routed (similar to what's happening already), but this is unrelated to the demand side. Even if settled in Yuan, presumably the ROW prices oil in dollars still.

 

Lots of unpredictable drama, disruption, and 'accidents' - but ultimately it settles when a sanctioned barrel goes for the same price as an unsanctioned one. Sanctioned barrels trade at roughly a 25-30% discount - the higher cost of transport (transfers & additional distance) - the costs of bribes/'insurance'. A simply spilt of the difference, and the price of an unsanctioned barrel drops $15-20.

 

Of course, should a key sanctioned facility experience a similar event to the Nord Stream pipeline, the rise in the unsanctioned price gets offset by the presence of the sanctioned oil - and everyone doing all they can to get it back into production ....

 

SD 

Edited December 4, 2022 by SharperDingaan

[Viking]

What a crazy year it has been; not just for energy but for all asset classes. 
 

Regarding energy, i follow the large Canadian producers the closest. Cash flow in 2022 has been amazing. Most of the cash flow has gone to debt repayment. Net debt levels in the Canadian oil patch have got to be at historically low levels. Balance sheets have largely been de-levered over the past 2 years which is a significant achievement. The interest expense savings for all companies will also be material moving forward (lowering their per barrel break even cost). 
 

As we end 2022, we are seeing more and more producers shift more and more of their free cash flow to investors. In Q4 MEG moved to 50% to share buybacks (was 100% debt reduction). In January 2023, CVE will be 100% to dividends, special dividends and share buybacks (with net debt at their $4 billion mark). Every company is materially increasing the % of free cash flow that is being returned to investors. All Canadian oil patch companies will likely hit their final net debt targets in 2023. The amount of money that will be returned to investors will be massive. 
 

My guess is the amount of stock buybacks that will be done moving forward will start to provide a floor for share prices of energy companies. If share prices get too high… energy companies will shift to special dividends. 
 

So how does and investor value a company that has little debt, solid free cash flow and is committed to returning an increasing % of free cash flow to investors?

 

i ask because it is pretty clear no one is actually doing the math on Canadian oil companies. We learn that a stock is worth the discounted value of future cash flows. This does not apply to the Canadian oils (perhaps the US too… i just don’t follow them). 
 

So what is an investor to do? Wait. Give it time. Mr Market will eventually get it right. And patient shareholders will make out like bandits.
—————

Even if oil sticks at US$70, the Canadian producers will still be gushing cash. And it their shares get pummelled (likely), with debt targets largely hit, they will be able to buy back meaningful amounts of shares a rock bottom prices.
 

It really is a crazy set up. Regardless of where oil prices go in the short term, oil investors should do very well looking out a couple of years.
 

I wonder if we do not see the next wave of consolidation happen in the Canadian oil patch over the next year. European and Chinese producers desperately want out. Canadian producers may get their ‘buy low’ opportunity. 

Edited December 7, 2022 by Viking

[Spekulatius]

On 12/3/2022 at 10:09 PM, Dinar said:

I read somewhere that Europe could cut its nat gas consumption by 25% if it lowered thermostats in winter by 3 degrees Celsius and raised them as much in the summer.  I do not know whether that is true or not, but if true, there is a lot of demand destruction that can happen world wide if people accept less comfort.  Even 10% would be a gigantic change.

Most homes in Europe don’t have air conditioning ,even a lot of offices do not. So raising thermostats in summer is not going to do all that much. As for the winter, I think Europe is already at ~25% savings run rate. Barring a very cold weather, I think Europe will get through this winter better than most expected.

[Sweet]

I agree Spec, I think Europe will rumble on through.  I think the biggest risk isn’t heat though, it’s electricity generation.  To add to you risk of extreme cold I also say a lack of wind power.

[Sweet]

Ed Morse was the only guy who got the back end of the year correct:

https://www.bloomberg.com/media-manifest/videos/android/WiFi/8e875ff8-7157-4193-8835-c707adb0a8c8.m3u8?idType=BMMP
 

[Spekulatius]

good read:

https://www.wsj.com/articles/natural-gas-terminal-engineering-feat-germany-11670513353?mod=hp_lead_pos10

[lnofeisone]

On 12/6/2022 at 7:35 PM, Spekulatius said:

Most homes in Europe don’t have air conditioning ,even a lot of offices do not. So raising thermostats in summer is not going to do all that much. As for the winter, I think Europe is already at ~25% savings run rate. Barring a very cold weather, I think Europe will get through this winter better than most expected.

I'm using Germany as proxy. Right now Germany is at roughly 15% goal of saving for household and industry. Industry is doing way better than households. Last week average temperature dropped by 0.2C and household consumption shot up. This week is expected 2C lower than average. We are in early innings of winter. So far it's been warmer but the trend has reversed. Looking at first derivative of how much gas is in storage vs. 5 year average doesn't paint a good picture.

 

Germany publishes very good numbers if anyone is looking (https://www.bundesnetzagentur.de/EN/Areas/Energy/Companies/SecurityOfSupply/GasSupply/start.html) 

[Spekulatius]

Looks like energy stocks have diverged from the underlying crude. I think this divergence will close one way or another:

[LC]

Yeah I've noticed this over the past month or so and have been trimming the energy component of my portfolio. 

[Viking]

My guess is one of the reasons for the divergence is the significant stock buybacks that are happening. They will be increasing as more debt targets are getting achieved. 
—————

In the near term, i have no idea where the price of oil will trade. I continue to love the set up for oil looking out a couple of years. Constrained supply. And increasing demand. With more and more cash flow being returned to shareholders.

[jfan]

Perhaps there is also a bit of a seasonal effect in play as well. 

 

 

 

[modiva]

Many large energy companies are increasing their CAPEX in 2023 which is bullish for the market. As the stocks look 6-12 months ahead, it is possible sign that the prices are likely to catch up to the stock prices (vs the other way round)? 

[Spekulatius]

2 hours ago, Viking said:

My guess is one of the reasons for the divergence is the significant stock buybacks that are happening. They will be increasing as more debt targets are getting achieved. 
—————

In the near term, i have no idea where the price of oil will trade. I continue to love the set up for oil looking out a couple of years. Constrained supply. And increasing demand. With more and more cash flow being returned to shareholders.

These buybacks only work LT (over many years) not short terms though. My guess is that energy securities have caught a bid, maybe funds want to show something that looks like a winning trade at the year end. We have seen similar things in the past.

 

Who knows. As I stated, I think it gets resolved one way or another and the correlation between crude and XLE will tighten again.

Edited December 10, 2022 by Spekulatius