The Last Great Chance to Buy Oil & Gas Stocks

Transcription

1 A PEAK OIL PLATEAU SPECIAL REPORT The Last Great Chance to Buy Oil & Gas Stocks Analysis by Kirk Spano Owner of fee-only Registered Investment Advisor: Bluemound Asset Management, LLC Publisher of Fundamental Trends Investment Letter: FundamentalTrends.com Columnist for MarketWatch.com of the Wall Street Journal network.

2 DEVELOPMENTS IN OIL AND GAS MARKETS This report was originally written in late November of This update is as of Saturday, April 4, So far, most of what I have said since summer of 2014 has come to pass. Oil prices have cratered reaching the low end of the range I predicted, rebounded on investors getting sucked into a value trap and are now retesting the bottom of that range once again. We will soon see if that bottom holds. A deal with Iran may push oil prices lower. Oil and gas stocks have plummeted. Many rebounded for a trade opportunity between late December and last February. Prices are heading down again as many companies scramble to maintain their capital structures. Borrowing and share issues have spiked this is not a good sign for shareholders. Many investors are starting to partially understand the geopolitical aspects of what is going on in the oil and gas markets, particularly with Russia and Iran. The dollar has continued to strengthen as nations around the world struggle to finance their debts and stimulate their economies. This has contributed greatly to fall in international oil and gas prices.

3 THE 2014 OIL MARKET THANKSGIVING STUFFING On June 5 th, 2014 in MarketWatch I gave this analysis and warning: a peak oil plateau is developing that could last the better part of two or three decades. The result will likely be a range bound price of petroleum that can be impacted in any short-term window by the usual international-event concerns and economic growth cycles. This range will be from around $80 per barrel to around $120 per barrel we were recently at about $103 on the July West Texas Crude (WTI) contract as companies and countries alike need to maintain a balanced pricing structure. That's not to say there can't be out of the ordinary price plunges or spikes, however, should those occur, that opens the door for unique leverage opportunities by enterprising investors. I believe there is a high probability that we do move to the low end of the oil-price range later this year On Thanksgiving, after I warned on Scutify.com and at The American Resource Boom Letter ahead of time, OPEC, led by Saudi Arabia, decided to allow oil supply to remain significantly above demand by not cutting their oil production which accounts for about 1/6 of global supply. On the Friday after Thanksgiving, the price of oil plunged, turning a slow drift downward into an avalanche.

4 MY GENERAL THESIS ON OIL AND GAS Oil demand will remain in the 90 something million barrels per day of demand for an extended period of time. Currently supply outstrips demand by about 2 million barrels per day globally. That is causing oil prices to be below the cost of production for a significant portion of the oil consumed globally. This will not last longer than a year or two. Supply will come more into line with demand by summer of 2016 as large producers abandon less profitable projects. We have already seen significant capex reductions for 2015 and This puts deep sea oil at a major disadvantage to ground based oil even fracked and tar sands oil. Geopolitical issues are important to be aware of. Russia and Iran need higher oil prices to finance their economies. This gives the U.S. and Saudi Arabia a tool to negotiate. Normalized oil prices will be in a range of $80/bbl to $120/bbl for the next two or three decades. Prices in the $80s and $90s should last for a few years. In the 2020s as electric vehicles become a larger part of the transportation mix, oil will start to see demand destruction. This coincides with when the U.S. fracking boom will be topping out. Supply and demand for oil will fall at similar rates until the daily demand for oil reaches between million barrels per day in the 2030s or 2040s. American oil and gas company profits will surge in coming years after the weak are forced out. Natural gas prices will rise to a range of $4 to $6 mmbtu. The greatest opportunity is in natural gas as the U.S. is on the verge of becoming a major exporter.

5 IS THIS A BUY LOW OPPORTUNITY FOR OIL? PREPARED NOVEMBER 2014 I expect oil to reach the lower $50s/barrel. That is nearly reflected in equity prices already.

6 Oil futures are double bottoming. How low will they go? (March 2015) In November I suggested oil prices would go into the lower $50s. That is about where significant support is. However, with storage nearly full in America at nearly 500 million barrels which is only about a month supply, we could see a breakthrough of even that low level briefly. Any such break lower will be a major buying opportunity as with reduced drilling starting to take hold and the summer driving season coming, we will see firming in prices by late summer. Oil and natural gas stocks won t bottom until after oil has bottomed. I d anticipate a one to two quarter lag.

7 WHAT IS CAUSING THE PRICE OF OIL TO FALL? Global oil demand is about 92 million barrels per day. Global oil production is about 94 million barrels per day. This imbalance is driving prices down. Many expected OPEC s Thanksgiving meeting to result in OPEC lowering oil production as noted, I did not expect that. On Thanksgiving, OPEC announced they would not be cutting production. Saudi Arabia wields the most influence in OPEC. They decided to maintain OPEC oil production. They have multiple motivations for not cutting OPEC production to balance the supply and demand imbalance: To put pressure on Russia which keeps the U.S. happy which in turn is important for Saudi Arabia s security relationship with the U.S. To put pressure on Iran, whom they hate and are afraid of, as well as once again satisfy the United State s desire to find a solution with Iran over their nuclear program. To put pressure on fringe oil producers in North America and other places. It should be noted that the U.S. administration and powers that be, do not want the United States to use up their oil reserve quickly for long-term strategic reasons. To force some consolidation in the oil market so fewer larger hands are on the controls, thus enabling more control over future pricing. To put pressure on alternative energy and electric vehicles. To stimulate economic growth, hopefully avoiding a global recession and create future demand for oil.

8 THE BIGGEST LOSERS WITH OIL UNDER $90/BBL ARE ON THE RIGHT RUSSIA, DEEP WATER Bloomberg

9 The American fracking boom is the key driver to changing the international oil & gas equation.

10 U.S. NATURAL GAS PRODUCTION HAS ALSO SURGED

11 OIL DEMAND HAS RISEN SLOWER THAN SUPPLY A peak oil plateau is developing in the middle 90 millions for oil demand and supply.

12 In addition to not cutting production, OPEC is actually exceeding their target. The result is an unknown excess supply of oil. Most analysts are using official numbers and suggesting a one million barrel per day overhang in supply. The more likely scenario is that oil over supply is closer to two million barrels of oil per day. This means that either demand needs to rise significantly faster or supply growth must suddenly stop in order to balance the market within a year. Most likely, the market does not balance until 2016.

13 MY TAKE ON THE FUTURE OF THE OIL MARKET Oil prices should stabilize by autumn of Oil prices will likely rise by summer of 2016 back into the $80s/bbl. Demand will continue to grow, although very slowly until the early 2020s. Demand will flatten in the 2020s as electric vehicles in the car market gain traction and natural gas engine trucks and buses also increase market share as cities look to reduce air pollution China is starting to move in this direction now and companies, as well as, municipalities seek to reduce maintenance costs in fleets. By the 2030s oil demand will see significant demand destruction, however, the supply of economically available oil will also start to fall. Throughout the next two to three decades, oil producers will keep a tight leash on the supply of oil relative to demand. The result will be an oil price per barrel in line with what many nations need to balance budgets. It should not be lost on people that the United States has environmental and economic reasons to not wanting oil and gas prices to remain low for long. The price of oil will usually be in an $80 to $120 per barrel price range for two to three decades.

14 THE BIGGEST OPPORTUNITIES ARE IN NATURAL GAS AS DEMAND INCREASES U.S. and China are reducing coal fired power plants. Most of the energy is being replaced by natural gas fired power pants. Natural gas engines for heavy vehicles is a slow moving trend likely to accelerate near the end of the decade due to pressure to reduce costs and pollution. In the short-term, a reduction in capex for new drilling will push natural gas prices back to about $4/mmbtu. In the long-term natural gas will continue to replace coal globally as most nations agree that global warming is a legitimate threat.

15 COAL DEMAND IS REALLY LEVELING OFF SOON IT WILL FALL

16 NATURAL GAS IS A BIG BENEFICIARY OF COAL DEMAND FLATTENING SO ARE RENEWABLES (DIFFERENT REPORT)

17 CHINA RECENTLY DECIDED TO CLOSE ALL COAL FIRED POWER PLANTS IN BEIJING. THE TREND IS EXPECTED TO EXPAND TO MOST CITIES IN ORDER TO REDUCE POLLUTION AND POLLUTION RELATED HEALTHCARE COSTS.

18 LIQUEFIED NATURAL GAS (LNG) IS SEEING HUGE CAPEX INVESTMENT EXAMPLE: SABINE PASS

19 SWITCH FROM COAL TO NAT GAS IN THE U.S. IS BECOMING DRAMATIC

20 NATURAL GAS PRICES HAVE NOWHERE TO GO BUT UP INTERMEDIATE TERM

21 THE U.S. IS ABOUT TO BECOME AN EXPORTER OF NATURAL GAS TO THE WORLD WITH THE OPENING OF SABINE PASS FACILITY

22 OIL & GAS STOCK PRICES AS DEMONSTRATED BY THE SPDR OIL & GAS EXPLORATION & PRODUCTION ETF (XOP).

23 OIL AND GAS SERVICES STOCKS REPRESENTED BY THE MARKET VECTORS OIL SERVICES ETF (OIH)

24 SO THE QUESTION BECOMES

25 ARE WE SEEING A BUY LOW OPPORTUNITY IN OIL AND GAS STOCKS? I believe the answer is about to become yes. Here s why: 1. Demand for oil is about 92 million barrels per day and relatively flat. 2. Supply growth for oil is still climbing due to prior projects. 3. It will only take about 6 to 18 months for marginal oil producers to feel the pain of lower oil prices and reduce capex (I wrote this in 2014, we are already at the front end of that range). 4. Recently we have seen record debt and equity issues by oil and gas producers to shore up their balance sheets. 5. Q2 earnings are likely to be a challenged at best and possibly a disaster. 6. Stock prices have not retested their bottoms. 7. There is a strong technical reason to believe that the weaker companies will break through their winter bottoms and drag down other companies in sympathy. 8. It is during that retest and potential break that the best opportunities will be found.

26 HOW WILL A REBOUND MANIFEST Oil focused companies will remain subject to geopolitical and economic pressure. Iran and Russia are not small problems. Deals with both nations are difficult to reach and measure. Saudi Arabia, even more than the United States, wants to control Iran. Lower oil prices are an economic stimulus that the United States wants so that it can exit the zero bound on interest rates. Oil centric companies face at least another year of lower profits, possibly two or three. Natural gas focused companies have significant catalysts for a faster rebound. The U.S. is about to become a natural gas superpower with exports beginning this year from Sabine Pass. A stronger dollar, likely with higher interest rates, makes U.S. natural gas more profitable to export without destroying demand necessities are less price elastic and in the case of natural gas inelastic for multiple reasons, i.e. alternative is Russia. China and the U.S. are motivated to most away from coal and towards natural gas.

27 A FEW WORDS ABOUT NATURAL GAS Companies break even on natural gas at prices of about $3.50 mmbtu. At $4 profits companies are profitable and at about $4.50 companies are comfortably profitable. Expect natural gas prices to be in the $4 to $6 range for a long time, with only occasional breaks out of this range like the past few years. Natural gas has long-term market support as many nations are trying to reduce coal for electricity generation by substituting natural gas, in an effort to reduce pollution. China is moving in this direction due to massive health concerns from their overwhelming smog in many cities. Natural gas engines for heavy vehicles are slowly gaining on their diesel counterparts as natural gas engines are cleaner, cheaper to operate and require less maintenance. Natural gas prices will be temporarily depressed as international natural gas prices are often tied to the price of oil. U.S. Liquid Natural Gas terminals are starting to come on line in the next few years and that should create stability in natural gas prices as excess inventory will be shipped. Europe will diversify by using some U.S. natural gas in order to rely less on Russia and the Middle East. I prefer companies with significant natural gas operations or potential as a risk management tool. There is an argument that companies with the most likelihood to spike upward in a few years are companies focused on liquids. That is probably true. However, longer term, natural gas is the story for buy and adjust investors looking for consistent market-beating results with lower risk than the broader market.

28 A FEW IMPORTANT THOUGHTS Companies that hedged their oil production will feel less immediate pain from falling oil prices. Many companies that did hedge, have their hedges end in January and July of 2015, exposing them to the lower oil prices that prevail into and past the first half of If low oil prices remain low longer than the summer of 2016, even many larger companies will feel significant pain. This is unlikely, but possible. If this were to occur, we are likely facing a global recession and possibly a financial crisis. Smaller companies, with high debt, operating in high cost shale plays are particularly vulnerable to the expected lower oil prices in We should expect to see consolidation in the industry that will lead to increased pricing power for the oil and gas industry by summer of Companies with natural gas assets to balance risks are in my opinion best positioned for the intermediate term, as natural gas become more pervasive as an electricity generation fuel and fuel for large vehicles.

29 WHAT OIL & GAS COMPANIES SHOULD WE BUY FOR THE INEVITABLE REBOUND? Primarily midsize companies that are big enough to scale and be flexible, but small enough to be takeover targets someday by the majors. Companies with solid balance sheets. Companies with great rock (acreage) and low extraction costs. Companies with expertise in hydraulic fracturing and/or Gulf of Mexico deep sea drilling. Companies with great management. Avoid small company speculation. There s no need to take the risk. Be patient. Too many investors are acting like emotional speculators and poor traders. Stop trying to catch falling knives. Very few are worth the effort or risk.

30 TRADING NOTES The recommendations contained are based upon noted criteria, my fundamental analysis, as well as, various technical and quantitative criteria. There are many risks to investing. With oil and gas companies there are risks that come from outside the United States borders and are influenced by many interests. Be aware of the risks. In general, positions should be built over a period of time to avoid quick decline risk. Position sizing is important. Do not over extend. My normal position building approach is 2% of portfolio first buy, 2% of portfolio second buy, 4% of portfolio third buy (or 2% LEAPs) it is rare this trade occurs. I may also buy LEAPs to coincide with catalysts, such as if we expect a change in OPEC policy at some time. I often simultaneously buy a stock and a sell a cash-secured put with a strike price near the 52 week low. This allows me to either defray my purchase price or average down on a position. Most of the companies included are good candidates for a cash-secured put strategy. I am not recommending many call strategies at this time due to the uncertainty of the short-term oil and gas markets. I am not suggesting any put strategies for betting against companies as most stock declines have already been steep and I can not monitor your trading effectively, however, I do note two companies that I believe are likely to have significant trouble at some time. I make no guarantees or warranties of any kind. You are responsible for executing trades and analyzing whether or not the investments are appropriate for your risk tolerance and financial situation. Remember, I am a position trader, not a swing trader. I expect to own positions from 2 to 7 years in most cases. Companies are listed alphabetically.

31 Anadarko Petroleum APC Net debt to adjusted capital has improved from 34% in 2012 to 24% now. Over $8 billion on the balance sheet. Diversified assets with flexibility for capital allocation, including Eagle Ford, Permian. Marcellus and Gulf of Mexico. Highly skilled in the field, including deep water drilling. Strong management team. Focus on monetization of asset base. Ability to strategically acquire assets if prices fall to their liking.

32 ANADARKO APC BUYING STRATEGY First purchase within 5% of 52 week low < $77.28 Or Sell a Cash Secured Put: February $77.50 at a limit of $5 GTC Second purchase at 10% below 52 week low = $66.24 Third purchase in the $40s where massive support develops I would likely buy LEAPs in that price range.

33 Carbo Ceramics CRR Debt free company providing synthetic frac sand. Synthetic frac sand is more effective than natural frac sand. As well completions become more difficult and mined frac sand more expensive as is happening in places like WI and NE Carbo will become even more competitive. Already strong margins. Price to Book near 1. Insiders own a significant percentage of the company.

34 CARBO CERAMICS CRR BUYING STRATEGY First purchase at market. Second purchase 10% below 52 week low = $32.09 Or Sell Cash Secured Puts: March $35 at a limit of $3.50 GTC. Third purchase in the middle $20s/share as this would represent a deep undervalued price. I would likely buy LEAPs in this price range.

35 Chesapeake Energy CHK $5.38 billion sale of some under capitalized land in Pennsylvania and West Virginia dramatically reduces Chesapeake financial pressures from it $11.3 billion of debt. Has prolific assets throughout most of America s shale plays, including Eagle Ford, Utica and Marcellus. Capex in 2015 will be equal to or below cash flow for first time in 7 years. Company is well hedged in case oil prices do not pick up by the end of Price to Book near 1. Good 70/30 oil/gas mix.

36 CHESAPEAKE CHK BUYING STRATEGY First purchase at market. Second purchase at 5% above 52 week low = $ Or Sell Cash Secured Puts: February $17 at a limit of.48 GTC Third purchase at 10% below 52 week low = $15.02 I would probably buy LEAPs in this price range.

37 Cimerax Energy XEC Very financially conservatively run company. Long-term debt to capital about 17% - low end of industry. Current Ratio 1.36 No bank debt. Ability to buy weakened competitors. Low cost assets in the Permian Basin and Cana-Woodford shale plays that are well supported by strong infrastructure. Sustainable growth rate in the low to middle teens. Approximately 50/50 oil/gas ratio. Not hedged beyond 2014.

38 CIMAREX XEC BUYING STRATEGY First buy within 5% of 52 week low < $97 Second buy at 10% below 52 week low = $83.14 Third buy in the lower $60s where very strong support begins.

39 Continental Resources CLR Historically strong exploration results in the Williston Basin. Low cost assets in Woodford and long-term assets in Niobrara. Mistakenly sold hedges earlier this autumn at a profit however. Will have to tighten reins on 2015 new drilling and capex the best they can. Significant debt of 39% long-term liabilities to capital. Potentially positioning for a V shape recovery in share price on future rise in oil prices. Hamm divorce is a consideration. High risk, high reward. Proved Reserves

40 CONTINENTAL RESOURCES CLR BUYING STRATEGY First buy 10% below 52 week low = $34.53 Second buy in the lower $20s presuming any credit problems appear temporary. Third buy in the upper single digits on speculation of a buyout or significant rebound. I would likely buy LEAPs in this price range if I was sure the company was not headed for bankruptcy (I don t believe it will go that route it is more likely it sells some assets or sells itself based on a negotiated future value of assets).

41 Devon Energy DVN Strong operations in Permian, Eagle Ford, Barnett and Anadarko. Long-term asset in Alberta. Well timed sales of international and domestic assets points to smart management motivated to remain financially strong and monetize kept assets. Oil is producing free cash flow and natural gas potential is high though currently not active (no rigs). Midstream operations. $3 billion on balance sheet against $12 billion in debt. Long-term liabilities only 20% vs total capital. Can cut dividend in a pinch.

42 DEVON ENERGY DVN BUYING STRATEGY First buy within 5% of 52 week low < $56 Second buy at 10% below 52 week low = $48 Third buy near 2009 crash lows in the lower to middle $40s. I would likely buy LEAPs in this price range.

43 EOG Resources EOG Outstanding crude oil assets, including Eagle Ford, Bakken and Delaware Basin / Permian (TX & NM). Most assets with break-even on oil in the $40s/bbl and $50s/bbl. Reduced Net Debt to Assets to 20% from 23% in High growth company. Has its own frac sand. Leader in completion design and execution. Not strongly hedged, look for further stock price drop to buy.

44 EOG RESOURCES EOG BUYING STRATEGY First purchase within 5% of 52 week low < $81.91 Second purchase at 10% below 52 week low = $70.21 Third purchase at about $58 per share where there is very strong support. I would likely buy LEAPs if EOG would reach the upper $50s.

45 Flotek Industries FTK Operates in energy chemicals, drilling technologies and production technologies for oil and gas industry. Low debt company with strong cash flow. Likely to see some constrained growth in 2015 which is being factored into share prices. Green biodegradable chemicals for hydraulic fracturing. International expansion. Clearly a takeover target. Acquisition of Florida Chemical was a good one. Is virtually unvalued by the market. Any upside is all extra. Management owns significant shares.

46 FLOTEK INDUSTRIES FTK BUYING STRATEGY First buy at market Second buy at 10% below 52 week low = $16.13 Third buy around $10 which provides extremely strong support. I would likely buy LEAPs near this price area.

47 Halliburton HAL Regardless of merger with Baker Huhges is a well positioned leader in oil and gas services would be even more so if merger completes. Company is running at capacity. Deep water revenue is rebounding strongly, though could see set-back in Shale field experts. Strong balance sheet with over $2 billion in cash. ROE over 20% Company could benefit greatly from some smaller North American players in pressure pumping feeling financial pressure in 2015.

48 HALLIBURTON HAL BUYING STRATEGY First buy at market. Second buy at 10% below 52 week low = $36.22 Third buy in upper $20s where support is very strong. I would likely buy LEAPs in this price area.

49 Marathon Oil MRO Has increased E&P from 39% domestic to 52% domestic past three years. Focused on Eagle Ford, Bakken and Oklahoma shale plays. Recently completed $2.1 billion sale in Norway to add to already strong balance sheet. Long-term liabilities to assets a near industry leading 17.4%. Has flexibility to purchase struggling companies or add to capital expenditures as it sees fit. Strong long-term and international assets.

50 MARATHON OIL MRO BUYING STRATEGY First purchase within 5% of 52 week low < $ Second purchase at 10% below 52 week low = $25.39 Third purchase at $22 per share where there is very strong support. I would likely buy LEAPs if MRO reached the lower $20s.

51 Pioneer Natural Resources PXD A financially conservatively run company with strong balance sheet and low debt ratios. Very well hedged oil production going into 2015 with most production hedged at $88/bbl. Will raise even more cash about $1 billion by selling EFS Midstream holding. Very strong asset base in Texas, including Eagle Ford. Spraberry/Wolfcamp resource potential significantly unlocked over the past few years via conversion from vertical to horizontal drilling. Smart water and sand strategies.

52 PIONEER NATURAL RESOURCES - PXD First buy within 5% of 52 week low < $ Second buy 10% below 52 week low = $ Third buy in the $80s where there is a wide band of supports. I would likely buy LEAPs in this price range.

53 Whiting Petroleum WLL Similar to Continental but better operated financially. Fantastic Bakken assets and longterm Niobrara assets. Substantial expertise in efficient development. Takeover of Kodiak appears secure KOG needs the deal and is well constructed for WLL. Whiting has a moderate level of debt which could necessitate a more conservative growth trajectory and hold share prices back in Could sell Permian or other non-core assets if necessary to develop Bakken and Niobrara if short-term proves difficult as I expect. Positioned well for a rebound in oil prices due to oil and liquids rich asset mix.

54 WHITING PETROLEUM WLL BUYING STRATEGY First buy within 5% of 52 week low < $39.59 Second buy at 10% below 52 week low = $34.16 Third buy in the low to middle $20s where there is massive support. I would likely buy LEAPs in this price range.

55 TWO COMPANIES WITH DEBT TROUBLES EP Energy EPE Current ratio of.59 exposes them to debt issues. Long-term liabilities to capital is very high at 48%. Mediocre assets at the edges of several shale plays hinders ability to sell an asset for financing. IPO appears to have been a classic exit strategy by smart money. Possible take private candidate at lower prices by private equity firm possibly Apollo Global Management. Linn Energy - LINE Extremely high debt burden of approximately 58% long-term liabilities to capital. Finances company through raising money, not generating free cash flow. Highly leveraged to high oil and gas prices. Even in a range bound price regime would likely have financial problems could be the straw that breaks the camel s back.

56 KEY RESEARCH SOURCES Energy Information Agency Assumptions to the Annual Energy Outlook 2014 Going Global: Tight Oil Production International Energy Outlook 2014 International Energy Agency Oil Market Report Oil Medium-term Market Report 2014 Natural Gas Medium-term Market Report 2014 (exec summary link only) World Energy Investment Outlook World Energy Outlook 2014 (exec summary link only) Key World Energy Statistics Congressional Research Service An Overview of Unconventional Oil & Natural Gas: Resources and Federal Actions Nov 2014 International Gas Union World LNG Report 2014 Edition

57 RESEARCH AND RECOMMENDATIONS ON COMPANIES TARGETED FOR INVESTMENT 4 categories of companies Access to specific research Natural gas focused exploration and production companies. Oil focused exploration and production companies. Oil & gas service stocks. Infrastructure companies, i.e. pipelines, storage and facility. Subscribers to Fundamental Trends who receive a complete trading and investment strategy using both fundamental research and quantitative analysis of all sectors for $399/year now with $120 off the first year when using discount code: 120off or Quarterly subscribers for $119/quarter

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