JotCast | 7/27/22 Capitalist Times Live Chat

Return to

7/27/22 Capitalist Times Live Chat

powered by

Prev Page View Full Chat Next Page

Elliott Gue

2:08

The set-up is very similar to what we saw back in the 1970s and the only “cure” is sustained, higher oil prices for several years that provide an economic incentive for additional capital spending (CAPEX). Not a “spike” higher in oil but sustained high prices.
Yes, government policy can have an impact and those risks are skewed to the upside for oil/gas prices.
Just consider that no company is going to invest in a major new oil project or drilling program unless they’re reasonably confident they’ll receive a return on that investment that exceeds their cost of capital.
Two crucial and interrelated pieces to instilling that confidence are that oil prices are high enough to support a return on capital and that there’s at least a stable government policy toward the industry. By that I mean they’ll be allowed to build the infrastructure needed to extract value from their investment – i.e. pipelines and storage infrastructure – and that they’ll be free from major surprise costs such as onerous confiscatory windf

2:09

windfall taxes, anti-fossil fuel rhetoric and policies (such as permitting delays).
Of course, needed CAPEX can still happen even with a hostile government it would just mean that companies would need to see a higher return and faster payback to compensate for the elevated regulatory risk. Of course, highe and faster return on investment translates to higher for longer commodity prices.
Historically, a combination of a bearish near-term demand outlook coupled with a bullish supply outlook (shortages and need for more CAPEX) translates to short-lived and relatively mild declines in oil prices amid a broader higher-for-longer oil price environment.

In this case, we see the potential for downside moves in WTI to the $70 to $80/bbl range amid a US recession (perhaps short-lived spikes below that range) but the broader tide will favor higher prices – well above that $70 to $80/bbl range on average with plenty of upside spikes well north of $100/bbl – to incentive more CAPEX.
This environment also suggests significant higher highs in energy stocks broadly in coming years – I continue to see us in the opening innings of a multi-year bull market for the sector. The sector must get bigger – much bigger – in order to be financially capable of funding the needed CAPEX.
Predicting the exact timing of all these trends and moves is tough to say the least. Generally, we’re looking for the recession to start late this year or early next year. Bear markets in the S&P 500 generally start before the recession begins (the peak was early January 2022) and the market bottoms before the economy exits recession.

So, generally that points to market weakness well into the first half of 2023. Energy stocks aren’t exactly on the same schedule as the S&P 500 but in a violent bear market sell-off, the sector is unlikely to be completely immune.
We’d regard weakness in our favorite names as a buying opportunity just as dips in the group were an outstanding buying opportunity back in the 70s and again in the 2001-2003 period.

Q: Also, do you think going forward we should put more investment dollars into exploration and production companies skewed towards natural gas, or to oil? Short term, what area of the energy industry do you feel has the greatest upside potential, upstream, midstream or refining? If the stock market keeps heading south, what would you use as a sign that it has reached bottom, and we can start reinvesting in energy stocks?

2:10

A: We’re in favor of balanced exposure to oil and gas exploration and production (E&P) companies over the intermediate to longer term.
We still see US natgas prices as a bit too high right now. US gas storage is well below normal (about 350 bcf in the most recent week) however, we’re still in the “average” range of the past 5 and 10 years and recent storage trends have been flattered by the heatwave in the Western US. Generally, as we move through summer and into autumn, I’d expect storage to normalize and prices to come down somewhat.
At the same time, the days of $2/MMBtu and $3/MMBtu gas are over – we see select gas-focused producers like Chesapeake (NYSE: CHK) well-positioned in the current environment and good buys especially on dips.
In a flat to down market for commodities and the market, midstream and supermajors like XOM are likely to be the most resilient buy candidates.

These will offer upside leverage as oil prices stabilize and begin to recover again, likely by early 2023. While you might need to endure some short-term downside we see even more upside leverage in E&Ps, refiners and select services names as the upcycle resumes. We’ll likely be using near-term dips to recommend buying.

Q: Hi Roger/Elliot. I won’t be around for the live chat on July 27th and would like to tee up the following questions. For those who doesn’t have much dry powder left to capitalize on the much-anticipated recession driven downturn in energy stocks in the later part of 2022 and early 2023, what would be your top 5 E&P and Mid-stream picks to add to existing positions, those that have the most appreciation potential from the current supply-led energy supercycle as well as the emerging LNG opportunities from EU’s decision to reduce reliance on Russian fossil fuels. Do you have any afterthought about your Baker Hughes (NYSE: BKR) recommendation after the recent revenue as well as bottom line miss in Q2?

A: Thanks for the question. We’ve winnowed the model portfolio down to what we believe to be the best of the best names, so we’d focus there when it comes to adding exposure on dips.
For the E&Ps, PXD is a low-cost producer in America’s most prolific field (the Permian) and we continue to like its policy of using variable dividends as a means of tying shareholder returns to business performance (it just paid $7.38 in quarterly dividends in mid-June). CHK is a quality natural gas producer with a similar high dividend strategy and we continue to see OXY as a strong buy candidate longer term as it normalizes its debt burden and restarts an aggressive capital return strategy.

2:11

Buffett’s recent buys have limited the downside in OXY relative to other E&P names, but it remains among the most positively leveraged to higher oil prices in our coverage universe.
While not really an E&P name – it’s a supermajor -- I still think it’s tough to go wrong with Exxon Mobil (XOM), so I’m going to throw it out there as a buy at this level. One of the only majors that counter-cyclically invested through the downcycle and with one of the best production profiles in the business.
As for midstream, I’d highlight EPD as a perennial best-of-breed and the company is now increasing its payout at the fastest pace since 2014. We also continue to like Energy Transfer (NYSE: ET) with improving distribution coverage and exposure to the liquefied natural gas and NGL export growth businesses.

As for BKR, the current shaky market environment is pretty merciless to any company that misses estimates, so BKR saw a nasty 8.3% hit on the trading day after its release. However, our take is that most of the miss was due to the faster-than-forecast wind-down of its Russian business and Russia-related hits to demand such as the fact that work has been halted on planned Russian LNG export capacity expansions.
Russia was a well-known headwind that was already priced into BKR shares in our view, but the speed of the wind-down differed from most analysts estimates.

However, the key point is that most of this Russia “noise” will likely be over by the end of this year and the longer-term outlook for investment in new LNG capacity continues to brighten. Simply put, the way – the ONLY way – for Europe to keep the lights on while reducing their extreme dependence on Moscow is to ramp up imports of LNG from other regions like the US. This won’t be easy, costless or fast, but I do think it’s likely to proceed and that means more demand for BKR equipment.
Of course, BKR’s traditional oilfield services business will also benefit from the general rise in capital spending needed to develop new oil and gas projects around the world in coming years. Short-term Russia noise aside, that’s well underway.
Indeed, you could say that what’s bad news today – a sanction- driven collapse in Russian energy investment – is great news for the cycle longer term as Russia is such a crucial oil and gas supplier that replacing those volumes will require even bigger CAPEX in other regions.

John C

2:12

one more name to please provide guidance on during 7/27 chat
Lumen tech (LUMN)

thanks

Roger Conrad

2:12

Hi John. Lumen reports Q2 results and updates guidance on August 3. The main questions will be progress on asset sales and debt reduction and how fast the legacy business eroded. There's a good chance the negative trends we saw in Q2 at AT&T and Verizon will show up there. And if that's the case, there will be more pressure on the dividend. I rated the stock a sell in Conrad's Utility Investor and it remains on the Endangered Dividends List. I think it's arguably already pricing in a cut but more bad news on revenue would I think pressure shares lower.

Teresa P

2:16

Hi Roger,

Would you please give us your thoughts on (1) the combined Healthcare Trust of America/Healthcare Realty now that the merger is complete and (2) Alexandria Real Estate after reporting earnings? Thank you

Roger Conrad

2:16

Hi Teresa. I liked Alexandria REIT's earnings, which I think affirmed the strength of the life sciences business. That starts with the boost in adjusted FFO guidance for 2022. But investment trends also look pretty healthy. I plan to repeat my recommendation of Buy<220 in the next REIT Sheet, which I intend to post after the rest of the recommended REITs reporting this week turn in their numbers. I think the Helathcare Realty merger will eventually create a stronger more resilient REIT in a sector that arguably needs for consolidation. HR is expected to announce earnings on August 3 and I expect to hear more detail about management's plans at that time.

Victor

2:21

Hello Gents and thank you for this service. What is a good source to see how much oil is produced in the US? I heard reports that we are now producing 12 MB a day and that we are now a net exporter again? Is that accurate?

Elliott Gue

2:21

The Energy Information Administration provides weekly production estimates for the US as part of their Petroleum Status Report here: https://www.eia.gov/petroleum/supply/weekly/
At the present time, the US produces just over 12 million bbl/day, up from a September 2021 low of under 10.5 million bbl/day, but still below the 2020 peak at a little over 13 million bbl/day. However, the US has not been a net exporter of oil in modern times -- US consumption of oil is close to 20 million bbl/day and total oil input into US refineries runs at around 16 to 17 million bbl/day. So even at the all-time peak, the US still needed imports.

Elliott Gue

2:21

US oil trade is generally about the "type" and location of oil. For example, US light sweet crude oil (most shale oil, for example) is in heavy demand overseas while US refineries run best with some mixture of heavy crude. So, that means US tends to export some types of crude and imports others.

David O

2:24

Roger, Retired, need income. No doubt you are sick of Verizon questions. VZ makes me sick, too. The more I buy, the lower it goes. Tempted to swap my VZ holdings into BCE. Is it as safe as VZ? Maybe swap half? Maybe just sit tight with VZ…pocket the dividend and wait several years for things to straighten out?

Roger Conrad

2:24

Verizon shares are down about -14% year to date, or about -10% including dividends. That's actually better than the S&P 500 and its yield is 3.5X higher. As I wrote in the July 22 Income Insights "Sliding Guidance: How Much Trouble for Big Telecom," Verizon earnings are being negatively impacted by consumer belt tightening, which is likely to persist if the economy enters recession as we think likely. On the other hand, it's arguably priced for that at 8.5X next 12 months earnings and a yield of 5.7%--which is still very well covered with free cash flow and should still be increased by about 2% in early September. Telecom is a depressed sector and I suspect BCE's Q2 results on Aug 4 will show some of the same effects of inflation--even T-Mobile suffered a revenue decline. But I do think these are cheap stocks that still dominate a growing industry and plan to continue holding them.

Pete

2:31

Hi Roger,
ENEL SpA stock keeps making new lows in the Milan stock exchange and in its ADR form in the US. Would you mind giving us an update. What are the institutional investors' concerns that prevents them to buy the stock when the valuation ratios are so low?
Thanks in advance

Roger Conrad

2:31

Hi Pete. I think it's basically macro concerns that are keeping the selling pressure on Enel SpA, with the effect greatest on the US price because of the Euro's collapse to near parity with the US dollar. The company will announce Q2 results and update guidance tomorrow "after market" and investors will be watching the impact of inflation and skyrocketing natural gas prices on earnings, especially in Europe. I expect to see some impact but also a great deal of progress for the primary driver of long-term growth--which is deploying renewable energy in Europe and Latin America. That to me is the reason for holding shares and to expect another dividend increase in November. As for institutions, it may be the company's emerging markets exposure holding them back--they currently own 50.6% of float. But of the 28 research houses tracking the stock, 22 rate it buy versus 5 holds and one sell (Citi)--who actually rates Enel's Spanish unit a buy. Bottom line--this one requires patience but still looks solid inside.

Lee O.

2:37

do you have any info on canadian cnq,cve

Roger Conrad

2:37

Hi Lee. We track both in our "Canada and Australia coverage universe, which is posted on the EIA website along with buy/hold/sell advice for every company we track. Canadian Natural Resources reports Q2 in early August and Cenovus tomorrow. I expect both had strong quarters in large part because of high oil and gas prices. Both companies were recently reaffirmed by S&P at investment grade after using free cash flow to cut debt. Both are benefitting from the additional pipeline capacity out of Alberta, starting with Enbridge's Line 3--and should see expanding market access in coming years, which should mean better selling prices. Both stocks will probably pull back a bit more in a recession. But they should head a lot higher in coming years. Of the two, Canadian Natural is probably the safer bet, due to size and diversification.

Victor

2:40

Hi Elliott, At what point the Biden administration is supposed to replenish the oil that they are releasing from the SPR at a rate never seen before. I saw in the news this week that they are planning to release even more oil. As a side note, they are sending millions of barrels of oil to China. How is that possible?

Elliott Gue

2:40

Last spring, the Biden administration announced a plan to release about 1 million barrels per day from the SPR for several months. The size of the SPR was around 475 million barrels as of July 22nd, down from about 620 million barrels one year ago and a peak close to 727 million barrels in 2010. Today, the SPR is about the same size as it was in the middle of 1985; however, since US oil consumption was much lower in 1985 than is the case today, the size of the SPR in terms of days of supply is significantly smaller. More oil is being released; however, that was expected because it was part of the initial release announcement last spring however, they're going to need to slow or halt releases later this year because, at some point, the market will begin to fret about the dwindling supply of this emergency reserve.

Elliott Gue

2:40

The White House did announce today some basic procedures for eventually replacing the oil currently being sold out of SPR though they don't anticipate acquisitions until after FY 2023. It's a lengthy document and I haven't yet had a chance to go through all the particulars. At first blush my best guess is that they want to do two things: 1. Reassure the market that the do not intend to deplete the SPR to the point its meaningless. 2. Maybe provide some visible longer-term demand for American crude to boost long-term prices and encourage production. However, my view remains that SPR releases haven't done much to quell the rise in prices and I'm not sure that a plan to eventual refill SPR will have much of an impact on prices. Re China, the US doesn't really export much oil to China at all -- in the entire month of April 2022, for example, it was less than 6 million barrels or less than 200,000 bbl/day. In contrast the European Union received almost 50 million bbl of American oil in April.

Phil

2:45

Hi Roger - How does the current trade dispute with Mexico affect your view of ENLAY’s prospects? Many thanks for these very useful web chats

Roger Conrad

2:45

Hi Phil. Enel runs the vast majority of its Latin American operations outside of Chile through its Enel Americas unit--and that company has no exposure to Mexico. Rather, Brazil and Colombia are currently the two most important places it does business, though it also has operations in Argentina, Costa Rica, Guatemala, Panama and Peru. The company does have three completed facilities in Mexico that have been completed but after two years are still waiting for permits from the government to operate at a total estimated cost of $507 mil. But these are not a major item for earnings. And it seems likely they'll eventually generate electricity, either from a agreement with the government or when the current president of Mexico leaves office.

Ben F

2:50

Good morning from New Mexico -

Thoughts on Verizon and T and their recent earnings.

Thank you for all the hard work and sage advice.

Cheers

Roger Conrad

2:50

Hi Ben. Thanks for joining us today. I don't want to repeat what I've already said in the chat, as well as my July 22 Income Insights on that subject. I would say again as a general comment that both companies have clearly been negatively impacted by inflation and the growing likelihood of recession--which is also pressuring the communications sector as a whole. And I don't like the fact that both companies have reduced elements of their 2022 guidance twice already this year. But the long-term picture for both is still pretty bright--as first businesses and later consumers begin to adopt applications that reveal the potential of 5G. And I think a lot of people forget communications is not a shrinking business but one that's arguably increasingly essential. And T, VZ and TMUS dominate it in this country. Not a bad business to be in long-term and T and VZ at least are very cheap high yielding stocks.

Victor

2:55

Hi Elliott, Thank you for your mid year commodity update of your last report. Very good analysis on the economy, recession indicators and oil prices. I think that's is fair to say that we already entered a recession. The fact that the Fed will most probably increase rates can only add fuel to the fire. The news about Walmart are showing signs that there is an ongoing contraction in the economy. The housing market is already impacted. It's not a sellers market any more. As you mentioned oil stocks are not immune but given the fact that many of them already dropped significantly from their highs, isn't it that the bad news are already factored in the price of oil stocks? Do you really see them dropping significantly more from these levels?

Elliott Gue

2:55

Thanks for the question and kind comments about the commodity update issue. I do think that recession is a near-certainty at this point in the US and all but a "done deal" in Europe. I also believe the stock market has more downside generally -- we're now seeing the long-awaited oversold bounce but the second wave of the decline, driven by a rapid decline in earnings expectations sill lies ahead in my view. Because of the bullish supply picture (basically a chronic shortage of crude) I think the decline in oil/natgas prices will be pretty mild and certainly nothing to compare with what we saw in the 2014 to 2020 era. However, I would be surprised, very surprised if energy stocks didn't fall somewhat in sympathy with the broader market because a lot of the selling pressure is probably based on investors selling off their equity holdings en masse without much regard to company-specific fundamentals.

Elliott Gue

2:55

It's too early yet to be exact with a prediction but back in 2001-02 the S&P 500 Energy Index declined 36% from peak to trough amid the 2001 recession and 2000-02 bear market. The recent peak-to-trough decline for the S&P 500 Energy Index is about 26%. I suspect (again little more than an educated guess at this time) that the current economic downturn will be more severe than 2001, but less severe than 2007-09. And like 2001 the supply side is bullish while the near-term demand outlook for oil is mixed-to-bearish. So, as a very early guesstimate, I could easily see 10% to 15% of additional downside from the recent lows in energy stocks as consistent with my broader market outlook.

Hans

2:58

Elliott, Is there any reason to hold on to KOLD since Natl Gas prices have not come down this summer.

Elliott Gue

2:58

We got a big sell-off in gas in June from $9.50/MMbtu to $5.50. Unfortunately that was quickly followed by a rebound to the highs. I still see gas coming down to $4.50 to $5 as the summer heat passes by September/October. We recommended a short in gas for the CT Trader service and (thankfully) took a profit on half the position last December. At this time we're just recommending readers hold the remaining small position short gas as we see current elevated prices as unsustainable (in the US, not EU where the gas situation is very different).

Terry

2:59

If one believes that we are headed for a recession and that interest rates will likely be higher than most expect, many stocks will be selling for lower prices in the future. This would argue for lightening up on certain stocks and temporarily allocating to short term treasuries. Utilities without short term catalysts would seem to be candidates for this strategy. What are your views?

Roger Conrad

2:59

Hi Terry. I think the risk of a recession is very real at this time. And while the benchmark 10-year Treasury yield has dropped from 3.48% to 2.77% in the last month or so, borrowing rates are certainly meaningfully higher than they were at the beginning of the year. The key for utilities' performance in this environment, however, is I think whether they're able to stick to long-term earnings and dividend growth guidance--which currently is at or above inflation for best in class companies. If they can do that, it's hard to see any rationale for selling long-held positions and paying taxes on the gains, as any losses will be along the lines of what we've seen so far. Rather, I advocate the same strategy we've followed successfully the past few years: Take money off the table in utilities only when businesses weaken or prices reach unsustainable valuations--and look to add to positions when prices drop, preferably to "Dream" levels that I highlight in every issue.

Hans

3:03

Elliott, With the release of oil from the SPR is stopped would this not reduce the supply and therefore increase oil prices with the demand about the same. Thanks

Connecting…

Your current subscriptions

None

Register now to continue managing your subscriptions

E-mail Address	Chat Owner	Status	Remove

Enter your email address to be notified when Sherry Roberts hosts a chat