Jennifer Warren Positions For 2019: Energy, Opportunities, And Acceptable Risk

Renewable Energy
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It has been a roller coaster ride for energy investors in 2018.

Yet, despite all the volatility in this key market, opportunities continue to surface. Energy expert Jennifer Warren, in this Positions For 2019 installment, offers ideas on how investors can navigate these choppy waters. She also presents her viewpoints on how the geopolitical landscape is shaping energy markets worldwide.

Her assessment follows:

(Q): What will be a key driver in oil markets?

(JW): The need for energy is certain – everything surrounding it is less certain. Both the supply and demand side of oil have proven hard to predict. And economic growth outlooks for both the U.S. and China have softened from recent trajectories. Supply excesses are a short-term issue, however. According to projections, future production expectations for the U.S. and Russia seem to err on the higher side. And finally, geopolitical shifts and more unexpected twists from an expanded OPEC pact is possible.

On the supply side, only a few months back, oil markets appeared to be on the tighter side, largely because of geopolitical-induced outages and OPEC-plus restraint. More recently, after larger inventories became apparent and bearish sentiment washed over the market, OPEC plus Russia agreed to cut 1.2 million b/d to reduce inventories. The Wall Street Journal reports: “Russia will curb its output by 230,000 barrels a day, slightly less than Saudi Arabia, which is reducing by a daily 250,000 barrels. OPEC granted exemptions to Iran, Libya, Venezuela and Nigeria, which had argued to be left out of the cuts due to economic strife in their countries.” Iran’s U.S.-sanctions problem softened from the waivers granted by the U.S. government. Many implications remain pending from the geopolitics of Iran and sanctions.

The chart below about price speaks to the recent shifts in oil prices and the new response by producers. U.S. producers are reining in capex. Raymond James says the industry will reduce budgets by 10%-15% year-over-year. Thus, short-cycle shale will adjust accordingly. It already is in the EIA’s December drilling productivity report and the recent decline in the rig count.

Source: WSJ, Dec 10, 2018

As of Dec. 11, the U.S. Energy Information Agency estimates that U.S. crude oil production averaged 11.5 million barrels per day (b/d) in November, up 150,000 b/d from October levels. Crude oil production will average 10.9 million b/d in 2018, up from 9.4 million last year, and is forecast to average 12.1 million b/d in 2019. This estimate factors in WTI of $54 and Brent crude of $61, on average, for 2019. The current lower price environment is factored in.

A Citi presentation1 from a September Dallas Federal Reserve Bank symposium projects the following below. The analyst also noted that Russia, Saudi Arabia and the U.S. account for roughly 40 million b/d of the 100-million b/d global fuel market in 2018. What a difference a decade makes for the U.S. in terms of production. U.S. crude and liquids are expected to increase, but this calculus was based on slightly higher oil prices.

According to a recent Economist report, Russian production will increase because of private-owned oil producers need to produce.2 Interestingly, the Citi presentation notes that Russia has greenfield projects amounting to a 1.4 million b/d tailwind for supply to 2022. The short-term and longer-term conflicts of interest will be a difficult juggling act between Russia and OPEC. Qatar just quit the OPEC pact because of the new partnership’s dynamics.

Importantly, the U.S.-Russia-Saudi Arabia supply triumvirate produces the lion’s share of oil. Demand is still growing, largely from developing countries. However, U.S. economic growth is projected to decline from its current 2.9% to 2.2% in 2019; China’s growth declines from 6.6% to 6.2% in 2019-2020, from its own structural issues but also potentially the trade wars.3 U.S. producers, the greatest adherents to the dictates of the market, are a positive force for world oil markets.

(Q): As we approach 2019, what is your position on U.S. stocks or your preferred asset class?

(JW): I’m cautious about the overall market and believe cash is a viable addition to diversify and add some element of defensiveness. In the long and even medium term, I’m staying the course in energy based on fundamentals and the continued need to satisfy economies’ demand for energy. But there are changing energy mixes and trade patterns emerging to watch.

(Q): In terms of specific companies or stocks, anything investors should watch next year? Any Permian players, or others?

(JW): I will be sticking with Occidental Petroleum (OXY) and Exxon Mobil (XOM) as my long, larger-cap players with Permian interests that offer a dividend. I find the renewal of North Sea production interesting and have heard from an oil-connected U.S. technology firm that their offshore business is growing overall. This firm is part of the efficiency and cost reductions story of U.S. production which will trickle across the globe. In a case study, they saved a large E&P firm $500,000 in logistics/equipment in one year. This kind of anecdotal evidence bodes well for U.S. production in a constrained price environment.

In addition, the European majors such as British Petroleum (BP), Shell (NYSE:RDS.A) (RDS.B) and Total (TOT) pique my interest. Their strategic directions are important to follow from a lower-carbon economy perspective.

A relatively new exchange-traded fund called “BOON” (BOON) is worth monitoring. This fund tracks an index called the Pickens Oil Response Index. The Index is a composite of firms related to energy, and the price of Brent crude oil is the “common thread” by which stocks are selected. Alongside traditional supplier-firm (upstream-oriented) constituents, the Index includes other industries that meet a certain criteria related to energy investing. The index aims to mitigate the downside of the commodity cycles while preserving the upside potential associated with traditional energy equities investment. It includes an end-user or energy-consumer segment that helps diversify the fund.

The ETF is designed to capture changes in energy’s future, not just the oil patch play. “That’s evidenced by the fact that First Solar (NASDAQ:FSLR) made it into the index by the established rules and criteria,” Loftin, the fund’s managing director, says in an article. “It’s there because of the beginning of the change toward renewable energy.” The energy tech sector is represented in the index, too. (See story for an overview – their website contains extensive information.)

This ETF is essentially a diversified energy fund that looks at the present and future of the energy transition. It’s also a way to hold a number of oil and gas firms – such as Concho (CXO), Diamondback (FANG) and Cabot (COG) -with less volatility. From 9/31 to 10/31, the index shaved the energy segment to 49.6% from 52.45% and consumers up to 7.5% from 3.6%, reflecting declining oil prices. (The thinking that consumers benefit from declining oil prices.) By the end of November, energy decreased to 47%, materials increased slightly and consumer cyclicals declined slightly.4

(Q): Which domestic/global issue is most likely to adversely affect U.S. markets in the coming year?

(JW): The continued erosion of confidence in governance and whiplash of policy pronouncements. The choice of addressing policy initiatives that satisfy immediate grievances vs. longer term structural issues is a negative. For example, the tax reform that gave corporate America a short-term windfall but burdened taxpayers with a mounting future deficit. Post reform, the economic outlook has begun to deteriorate, like a hangover after too much rum punch. The trade dispute with China has dampened economic outlooks across the globe. This issue has yet to fully reveal itself. There are obvious consequences and unintended consequences, economically and geopolitically, which may take years to reconcile. The sentiment conveyed in the House elections and the run-up to 2020 presidential elections will also create uncertainty.

(Q): What impacts and role do you think monetary policy will have on the equity market and the economy in general?

(JW): The Fed is the one bright spot in terms of economic stability and governance. In November, I attended an event at the Dallas Federal Reserve Bank featuring remarks by Chairman Jerome Powell. (Some thoughts afterward are here.) The return to some form of normalization is needed. Investors need choices beyond the stock market. The market needs a stabilizer in the form of competition vis-à-vis cash holdings and bonds.

(Q): What “surprise” do you see in the market that isn’t currently getting sufficient investor attention?

(JW): I am surprised, and yet not, that the oil market has been so jittery. But volatility is its nature. The lower prices and reduced production it brings will begat tightening supplies and higher prices at some point, but longer-term trends pull in the opposite direction. It’s hard to say how the pacing plays out. The energy transition also is tangential, though its direct effect is not quite fully factored into prices.

Another issue is when the U.S. deficit bill comes due, and it will, at a time when fewer workers can support current entitlements. Adjustments now can avert a crisis, potentially. If a recession arrives in say 2020, leaving fiscal policy on the defensive, kicking the can down the road will further exacerbate the problem.

(Q): What issue is receiving too much investor attention and/or already is priced in?

(JW): Rising interest rates, trade disputes and economic uncertainty are baked into the tech sell off. It reminds me of how energy stocks tanked after the oil price bust – they have not fully “recovered” and are still finding the new normal. If we could keep politics out of oil price movements, I suspect there would be less volatility.

Innovation adoption is a much slower prospect than how the media portrays innovation. This gets to the heart of the political challenge of the “divide” – the haves and have-nots, those thriving and adapting and those not. Economic changes from automation, innovation and related forces are increasingly a driver of politics and policy. It’s not being dealt with in a constructive way, which brings uncertainty, and therefore risk. The Fed is studying this and trying to determine how it impacts labor, prices, and the economy, and therefore monetary policy.

(Q): How does the political climate affect the risks and opportunities for next year?

(JW): I think one has to see through the politics and attempt to hold on to some fundamental beliefs about market forces and that some semblance of sanity will prevail. My final advice is to focus on the big picture, turning down the noise, to identify opportunities and acceptable risks.

    1. Here (pdf)
    2. Economist Intelligent Unit. “Turbulent Times: Measuring Real-Time Shifts in a Volatile Oil Market,” Dec 6, 2018.
    3. Ibid.
    4. BOON page on WSJ (10/31), E-Trade (11/30), and BOON website (9/30)

Disclosure: I am/we are long XOM, OXY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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