Eq: Energy (93)
On a shorter timeframe, oil has been enjoying a nice rally as it’s up nearly 30% since late-June. It’s largely being driven by the same catalyst that is affecting the stock market and bond market - recession risk in 2023 and early 2024 is being priced out, at least in the United States.
While the worst-case scenario for the economy has been taken off the table in the last couple of months, it’s also clear that the best-case scenario of a re-acceleration of growth is also unlikely given the spate of weaker than expected economic data released this week. The other major factor supporting prices is production cuts from OPEC+ countries who are looking to push prices higher. And, there are rumors that Russia and Saudi Arabia are expected to announce further cuts in the coming weeks.
On the bearish side, the major development is the deluge of data showing that China’s economy is much weaker than expected. Some of the weak data points include a drop in exports, consumption, and a nascent crisis in its real estate market. China is the world’s second-largest consumer of crude oil so this has major implications for its supply/demand dynamic.
Overall, oil is in a similar place to stocks and bonds. Amid a mix of bullish and bearish factors, it’s tough to determine whether this is a resumption of its bull market or simply an oversold bounce.
Finsum: Crude oil prices are up nearly 30% since late June. However, it’s tough to be confident about its long-term direction given the mix of bullish and bearish factors.
One of the biggest long-term issues affecting the energy sector is the growth of electric vehicles. According to the IEA, 50% of new vehicles sold will be EVs by 2030 with EV sales completely displacing traditional internal combustion engines (ICE) by 2050.
In Q2 of 2023, there was a new record in terms of sales in the US with nearly 300,000 EVs bought which comprises about 7% of the total sold. A big contributing factor is the Inflation Relief Act which offered subsidies for up to $7,500 for select EVs with many states offering additional subsidies.
Of course, this has major implications for gasoline demand which is a major component of crude oil use. And, it’s one reason why many are betting that global oil demand is peaking and set to decline over the coming decades.
This narrative is even affecting the supply side as many producers are using excess cash flow to pay off debt, distribute dividends, and strengthen their balance sheet rather than invest in new production. However, if this narrative turns out to be preemptive or incorrect, then there is likely going to be major upside for the energy sector.
Finsum: EV sales hit new record highs in Q2 of 2023 in part due to subsidies from the Inflation Relief Act. Whether EV sales keep rising is a major storyline in the energy market.
Energy stocks have underperformed in 2023 following a year of massive outperformance. YTD, the sector is up 5%, while the S&P 500 is up 15%. However, the sector continues to attract interest from value investors due to its low valuations and high dividend payments. The Energy Select SPDR (XLE) has a P/E of 8.2 and a dividend yield of 3.7% vs a P/E of 25 and yield of 1.5%.
Recent 13-F filings show that prominent value investors continue to build a position in the sector. Warren Buffett’s Berkshire Hathaway boosted its stake in Occidental Petroleum by 5% and now owns 25% of the company. Despite his appetite for the stock and approval from the SEC to buy up to 50% of the company, Buffett has dismissed speculation that he is looking to buy the whole company, remarking that “We’re not going to buy control. We wouldn’t know what to do with it.”
Carl Icahn also owns Occidental albeit a much smaller stake at 1.5%. He also owns positions in Southwestern Oil & Gas and CVR Energy. Like Buffett, his career has been defined by buying into industries that are unloved with compelling valuations that are being ignored by the broader market in favor of ‘hotter’ sectors.
Many see a looming catalyst for energy in that oil producers have reduced production in the second-half of the year which should provide a healthy tailwind for prices the rest of the year.
Finsum: The energy sector is one of the cheaper parts of the market. So, it’s not surprising to see that many value investors are making big bets on the sector.
The first-half of the year saw the energy sector underperform due to various headwinds such as the crisis in regional banks, concerns of a recession, high rates, tight monetary policy, stubborn inflation, etc. The second-half of the year has seen energy outperform as economic data continues to come stronger than expected and inflation has moderated, leading to more confidence that a soft landing outcome is likely.
For instance, crude oil started the year at around $80 per barrel but spent most of the first-half, trading between $60 and $70. In the second-half of the year, oil has traded between $70 and $80 for the most part.
In terms of the outlook for crude oil for the rest of the year, the major bullish catalysts are reduced output due to OPEC+ cuts while demand should remain resilient especially if a recession is avoided. However, there is a bearish catalyst on the horizon due to increasing concerns that China could already be in a recession.
Recent data coming out of the country has been quite poor. This has been underscored by the 8.5% decline in property investments and defaults from some high-profile developers. Retail sales data also missed badly at 2.5% growth vs expectations of 5.3%. Another concerning datapoint is the 14.5% decline in the country’s exports. These trends could undermine the nascent rally in crude oil given that it’s a major source of demand.
Finsum: Crude oil prices have enjoyed a nice rally in the second-half of the year, however a weakening Chinese economy could result in the rally fizzling out.
One of the biggest surprises of 2023 has been the incredible strength of equities with the S&P 500 up 18% YTD, and many stocks and sectors actually making new all-time highs despite numerous headwinds such as high inflation, a hawkish Fed, and middling economic growth.
Yet, this rally has seen the bulk of outperformance from the technology sector, while cyclical parts of the market such as energy have lagged. However, there are signs that this could be changing especially following the energy sector’s strong performance over the last month as evidenced by XLE’s 8% gain.
The larger impetus for cyclical stocks has been growing recognition that the US will likely avoid a recession in 2023. Energy stocks have also had other catalysts such as strong earnings reports from behemoths like Chevron and Exxon Mobil. Additional catalysts could be supply cuts from OPEC+ and the US refilling its strategic petroleum reserve (SPR).
The sector also remains attractive from a valuation perspective. Currently, XLE has a price-to-earnings ratio of 8 and a dividend yield of 3.7%. Compare this to the S&P 500’s price to earnings ratio of 25.8 and yield of 1.5%.
Finsum: The energy sector has enjoyed strong performance over the last month due to a spate of strong earnings reports and increasing signs that the US will avoid a recession.
In a piece for Marketwatch, Michael Brush covers an interesting dichotomy regarding the energy sector. Billionaires like Warren Buffett and company insiders are bullish as evidenced by their large buys since the beginning of the year. However, broader investor sentiment towards the sector remains bearish as evidenced by its low valuations and middling performance this year.
Brush believes that the odds favor insiders and Buffett being correct. He also notes that energy stocks are cheap relative to their price to earnings ratios on a 5-year average basis. He also sees OPEC+ cuts over the past few months as a bullish catalyst and notes some unusual factors for why they haven’t been effective in pushing prices higher already.
He believes that another bullish factor for energy is the relatively low amount of CAPEX. In 2022, investments in oil production were 40% below 2014. This is another positive tailwind for energy prices especially as demand should continue to remain resilient given that the US has so far avoided a recession.
He recommends seeking out energy stocks with strong patterns of insider buying, low valuations, and above-average yields and expects the sector to outperform in the second-half of the year.
Finsum: Energy stocks are exhibiting low valuations, insider buying, and aggressive buying by billionaires like Warren Buffett.
In an article for CNN Money, Krystal Hur covers why many Wall Street analysts continue to issue upbeat commentary and favorable ratings on energy stocks. This is despite the sector badly lagging the broader market in the first half of the year due to weakness in oil prices and underwhelming earnings results from the major oil producers.
However, analysts continue to see value in the sector. The energy sector has a forward P/E of 10.5 which is nearly half of the S&P 500. They also like the long-term bullish case for energy given the lack of CAPEX in the space over the past decade despite continued demand growth. Additionally, this past year has seen output cuts from OPEC+ while the US has been buying oil to replenish the strategic petroleum reserve.
Currently, analysts have a buy rating on 60% of stocks in the energy sector which is the most by far. In the first half of the year, the Energy Select SPDR (XLE) was down 8% while the S&P 500 was up 15%. Some reasons are mean-reversion following the sector’s nearly 60% gain last year, a weaker-than-expected Chinese economy, and Russia and other countries finding ways to elude sanctions.
Finsum: Energy stocks underperformed in the first half of the year, but Wall Street analysts continue to remain bullish on the sector due to longer-term supply concerns and compelling value.
In an article for Reuters, David Randall discusses the outlook for the energy sector in the second-half of the year, and why some contrarian investors are betting on a rebound. In the first-half of the year, energy underperformed the broader market despite economic growth performing better than expected, while OPEC countries embarked on supply cuts.
The major headwind for oil has been weak demand from Europe and China, resulting in oil prices that are down 10% YTD. Despite expectations of continued rate hikes in the coming months, many investors are increasing exposure to energy stocks due to attractive valuations and expectations of a pickup in economic growth.
Supply cuts from OPEC should also support the market especially as domestic US production has also been trending lower in recent months, reaching their lowest levels since April of last year.
On a valuation basis, the sector is quite cheap relative to the broader market with a cumulative forward price to earnings ratio of 10.4, while the S&P 500 has a forward price to earnings ratio of 19. The energy sector also pays a better yield at 3.9% vs 1.5%.
Finsum: Energy stocks underperformed in the first-half of the year following a strong 2022. Here’s why some are betting on a rebound in the second-half of the year.
In 2022, the energy sector was one of the few parts of the market that delivered positive returns for investors due to higher than expected global demand while supply was impacted by Russia’s invasion of Ukraine. However, the story is much different in 2023 as the sector is down 4% YTD, while the S&P 500 is up more than 16%.
In Q2, energy stocks also lagged the market as covered by David Meats for Morningstar. Not surprisingly, the major reason is that oil prices were down by 10% and natural gas was off by 27%. Many were caught offside by weakness in oil given cuts from OPEC over the past few months.
According to Meats, energy stocks remain overvalued as most investors continue to assume higher prices. While he is shying away from most parts of the energy sector, he sees value in oilfield services.
He believes the global oil market will be in a small deficit over the next couple of quarters due to the aforementioned cuts from OPEC in addition to stronger than expected economic growth. In total, he expects 2024 production to be about 1.1 million barrels per day lower than 2023.
Finsum: Energy has underperformed in 2023 despite cuts from OPEC and a better than expected economy. While most energy stocks are not attractive from a value perspective, oil services are an exception.
In an article for Bloomberg, Will Mathis covers how Shell and BP are retreating from its renewable energy projects in wind and solar due to lackluster returns and increased competition. It’s leading to opportunities for renewable firms who are no longer facing competition from Big Oil who are subsidizing projects with profits from oil and gas.
As these oil & gas companies entered the renewable space, they were willing to bid at lower prices than renewable firms in order to win government contracts, notably in offshore wind. However, returns on these projects have been middling, in part, due to inflation and supply chain constraints for key components.
Less than 4 years ago, Shell’s ambition was to be the world’s biggest producer of renewable energy. Now, it no longer has any sort of goal for renewable energy capacity and recently announced that it is upping capital expenditures on fossil fuels, likely due to continued, higher returns in the space. Similarly, BP is shifting away from solar and wind for similar reasons. Instead, it’s increasing spending on its biofuels and service stations while cutting back on renewables.
Yet, cumulative, global investments in renewables continue to increase with an expected $1.7 trillion in 2023 according to the IEA which is the 8th straight year of growth.
Finsum: Fossil fuel companies like BP and Shell are pulling back from renewable energy projects. However, global investment in renewables continues to increase, reaching an expected $1.7 trillion in 2023.
Even at his advanced age, Warren Buffett continues to make prescient moves. The most recent example includes loading up on energy stocks just prior to the sector’s incredible gains in 2020 and 2021. While prices have receded amid concerns that a recession is near, Buffett is using the weakness to increase his exposure to the sector.
However, his most aggressive bet in the sector is on Occidental Petroleum of which Berkshire owns 222 million shares which is equivalent to nearly 25% of the company’s market cap. While Occidental is an integrated operator, the bulk of its revenues are from drilling which means that it’s sensitive to swings in the price of crude oil.
Based on his public comments, Buffett sees the energy supply chain as being constrained given a lack of capital expenditures over the last decade, Russia’s invasion of Ukraine, and changes wrought by increased electrification. At the same time, global demand for oil continues to increase, leading to a tighter equilibrium between supply and demand.
In addition to his Occidental investment, Buffett also has a $22 billion stake in Chevron. Additionally, Berkshire Energy contributes $25 billion of revenue to its parent company and is composed of power generation and distribution companies like pipelines, renewables, and utilities.
Finsum: Energy has delivered poor returns in 2023 amid increased supply and growing recession fears. However, Warren Buffett continues to increase his exposure to the sector.
Last week, the International Energy Agency declared that the world will reach peak oil demand by the end of the decade. It attributes this to an increasing share of energy produced by renewables, the explosion in EV adoption, and continued increases in efficiency.
Due to these factors, it sees growth in oil demand growing marginally over the next few years before peaking in 2030. This year, the agency sees $2.8 trillion invested in the energy sector with $1.7 trillion going into non-fossil fuel sources like nuclear energy, renewables, and EVs.
Out of this group, solar is the leader with nearly $700 billion in investments which is nearly equivalent to all of the capital spending on oil. In total, fossil fuel investments which include coal, oil, and natural gas are expected to total $1 trillion.
In terms of EVs, the agency forecasts that 14 million will be sold this year. It also sees continued adoption with electric buses and trucks gaining market share.
Overall, the IEA believes that investors and fossil fuel companies need to make appropriate adjustments to account for these shifts in behavior and consumption.
Finsum: The IEA recently declared that oil demand will peak in 2030 due to increasing EV adoption, growth in renewables, and increasing efficiencies.
In an article previewing the first quarter earnings season for the energy sector for Zacks Investment Research, Sheraz Mian discussed the major factors for why analysts are forecasting 2023 earnings to decline by about 21% compared to 2022.
The major factor is that prices are down by about 25% when compared to last year. Additionally, costs are going up faster than expected, leading to downwards pressure on margins. Given these uncertainties, companies continue to be conservative in terms of CAPEX and optimizing balance sheet health.
In terms of the outlook for crude oil prices in 2023, the major headwind is weaker demand as economic growth decelerates across the world. Many expect the US economy to stumble into a recession later this year as the Fed keeps rates high to tamp down on inflationary pressures. Additionally, Chinese growth has also been less robust than expected following the end of its Covid policies.
This is sufficient enough of a headwind to offset bullish impulses from OPEC cutting production, sanctions on Russian oil production, and the US government restocking its depleted crude oil inventories.
Finsum: Earnings for the energy sector are expected to be down 21% compared to last year as recession concerns dominate.
In an article for the Financial Times, Derek Brower discussed recent weakness in energy stocks due to increasing worries of a recession despite a recent string of strong earnings reports. This follows a two year rally which was fueled by production cuts in 2020, a better than expected economy, and the war in Ukraine.
Last year, the energy sector was up more than 50%, while the S&P 500 finished down double-digits. This year in contrast, the S&P 500 has an 8% gain, while the energy sector is down 5%.
According to Wall Street analysts, investors are looking past companies’ strong results due to expectations that recent trouble in the banking sector will translate into reduced economic activity and demand for crude oil.
Another indication is that dividend yields in energy stocks are nearly double those found in financial stocks and quadruple those of tech stocks. Inflation is proving to be a significant headwind as production costs have increased, eroding margins with lower oil prices. Another is that productivity in the Permian Basin has declined by 30% over the last 2 years, another reason that margin contraction is likely.
Finsum: Following major outperformance in 2022, energy stocks have underperformed so far this year due to increasing recession fears.