Even though energy stocks are up 49% this year, executives keep buying their own companies’ shares.
Does that make sense? Yes, for two reasons. Oil will trade a lot higher next year, and energy stocks are still cheap.
First, oil. It will trade up 16% on average next year and spike up over 25%, says Francisco Blanch, the Bank of America head of global commodities and derivatives research. That would be bullish for energy stocks.
In a press briefing last week, he predicted Brent crude oil BRN00, +0.97% will average $100 per barrel next year, and trade as high as $110. Brent recently traded at $77 a barrel. Blanch thinks West Texas Intermediate crude oil CL.1, +2.08% will average $94 next year, compared with recent levels of around $72. I’ll tell you why this makes sense, below.
More on energy investing: These investors expect more gains for oil and gas stocks
On valuation, despite the big gains, energy stocks are cheap.
“These stocks are not expensive by any stretch,” says Ben Cook, who manages the Hennessy Energy Transition Investor fund HNRGX, -0.75%.
Large-cap exploration and production companies recently traded at 3.7 times EBITDA (earnings before interest, taxes, depreciation and amortization). Historically they have traded between four and six times, Cook says. Energy stocks make up 5% of the S&P 500 SPX, +0.43% — that’s well below the 8% average over the past 10 years.
“There is still money that can come back into the sector,” he says.
Cook is worth listening to because his Hennessy fund beats competitors in the energy equity category by 6 percentage points annualized over the past three years, according to Morningstar.
This also supports the valuation case: Bank of America’s Blanch doubts oil will fall much from here. He says “$80 is the new $60 for Brent,” a reference to the $60 bottom in the Brent trading range in recent years. Blanch cites production quota cuts by OPEC+, and the Biden administration commitment to begin refilling the strategic petroleum reserve if WTI falls below $80 a barrel.
In the big picture, Blanch thinks oil use per day will grow by 1.55 million barrels on a base of around 99.6 million barrels per day (BPD) this year. He thinks demand will reach 102.4 million BPD by the fourth quarter of next year, and that supply will struggle to keep up.
Here are five reasons why an undersupply of crude oil will benefit investors holding shares of oil companies.
1. China will reopen
China’s economy will pick up as zero Covid policies are eased and the government offers stimulus, says Blanch. “China needs to reopen because the U.S. and Europe will be in recession or close to it. So, China will face a tough time since it has been living off European and U.S. demand,” he says. Reopening would boost China’s oil demand by 5%.
2. The Federal Reserve will pivot during the first quarter
If Blanch is right and the Fed backs off on rate hikes over the next four months, that would be bullish for the global economy. His oil forecast assumes 2.4% global GDP growth next year. Along with global population growth, this will support oil demand.
3. Capacity is scarce
Chalk it up to chronic underinvestment in energy, says Steve Schuster, a money manager at Bridge Street Asset Management who has been bullish on energy stocks all year. “There has not been enough development in the pipeline.”
Blanch says OPEC+ is 3.4 million BPD short of its production targets, “a clear sign that OPEC+ has limited ability to meet rising demand volumes.” He notes Saudi Arabia and the United Arab Emirates combined have less than one million BPD of spare output.
To make matters worse, investment in new capacity lags. Blanch estimates it will hit $400 billion this year. That is low, historically. The last time oil averaged more than $100 per barrel in 2014, that figure was $761 billion for the year. “The global rig count is now half as sensitive to oil prices than it used to be. Historically, periods of very low spare capacity have been associated with higher than average realized oil prices,” says Blanch.
4. Inventories are still low
OECD petroleum stocks are at 3.96 billion barrels. That’s the lowest level for this time of year since at least 1986. “It is not going to take a lot to have oil prices go up,” says Blanch.
5. The U.S. won’t come to the rescue
U.S. shale companies have been the swing producers when oil prices spiked. But that’s not to happen again this time. U.S. producers were burned several times in the past decade by doing this. Now the mantra is financial discipline and returning cash to shareholders via dividends and buybacks.
That mindset will continue, says Cook. Besides, increasing production is challenging because of shortages of equipment and labor, and the rising costs of labor and supplies. Average rig day rates increased by nearly 50% this year and materials like steel pipe are up over 300% since early 2020, says Blanch.
He also says U.S. shale production inventory has fallen to a 10-year supply. “Doubling drilling brings inventory down to five years, and then your company is over,” he says. And the shale that remains is less productive. “The U.S. is no longer the swing producer,” concludes Blanch.
A simple way to get exposure is to buy shares of an energy fund like Cook’s Hennessy Energy Transition Investor or a large, broad-based ETF from the likes of State Street Global Advisors XLE, +1.97% or Vanguard VDE, +1.93%.
But if you like to own stocks, following insiders in energy can often pay off. I suggested Empire Petroleum Corp. EP, +9.72% in my stock letter, Brush Up on Stocks (the link is in the bio, below) in the $9 range on July 15, 2022, and within four months it was up 82%, compared to 34% for the Vanguard Energy Index Fund ETF.
New Fortress Energy NFE, +1.31% was up 395% since I suggested it on June 23, 2019, as of early December, compared with 73% for the Vanguard fund. I still like and own those names. But I’d rather suggest energy names with fresh insider buying closer to current levels.
Energy Transfer LP
- Distribution yield: 8.5%.
- Market cap: $38.7 billion.
- Insider buying: Energy Transfer LP ET, board chair and co-founder Kelcy Warren bought $73 million worth of partnership units at prices up to $12.39 in the past three months.
This midstream energy transport limited partnership benefits from increased natural gas demand in the U.S. and abroad. It also has a Lake Charles liquid natural gas plant that may get cleared to operate over the next several months, says Cook.
Texas Pacific Land
- Dividend yield: 0.47%.
- Market cap: $20 billion.
- Insider buying: A large owner called Horizon Kinetics Asset Management continues to buy rather than sell on phenomenal stock strength.
Texas Pacific Land Corp.’s TPL, +0.25% stock is up 44% since I suggested it in this fund manager profile column at around $1,800 in mid-September, five times more than energy ETFs. It is up 360% since I first suggested it in my stock letter in August 2020, more than twice that of energy funds. But it still looks worth buying.
Texas Pacific Land owns a lot of property in the energy-rich Permian Basin in western Texas. Its energy assets are 100% leased, but so far only 7% has been developed so the potential is huge, says James Davolos of the Kinetics Market Opportunities KMKNX, -1.09% and Kinetics Paradigm WWNPX, -1.02% funds.
Meanwhile, investors are undervaluing the company’s revenue from royalties on development rights leased to companies like Occidental Petroleum Corp. OXY, +2.24%, ConocoPhillips COP, +1.40% and Chevron CVX, +1.98%, says Davolos.
- Dividend yield: 2.5%.
- Market cap: $3.9 billion.
- Insider buying: A cluster of insiders including the CEO purchased over $2.5 million worth of stock at prices up to $19.50 in September.
Comstock Resources Inc. CRK, -0.54% is a natural gas producer in the Haynesville shale in North Louisiana and East Texas, an advantage since this is close to Gulf Coast LNG export plants.
WeatherBell Analytics forecasts a colder than normal winter this year. This would support natural gas prices in the near term. But one risk is that Blanch thinks natural gas prices will fall to $4.50 per MMBtu for the year in 2023 as supply grows to meet demand.
This scenario may already be priced in. The stock is cheap, says Schuster. It trades for an enterprise value to 2023 debt-adjusted cash flow ratio of 3.2, compared to 4 in a group of five U.S. mid-cap natural gas companies covered by Stifel. Dallas Cowboys owner and oil magnate Jerry Jones is the largest shareholder.
Black Stone Minerals LP
- Distribution yield: 10%
- Market cap: $3.9 billion
- Insider buying: CEO Tom Carter has purchased $2.6 million worth of stock at prices up to $19.50.
Black Stone Minerals LP BSM, +0.93% is primarily a natural gas producer with holdings in 41 states and all the major basins, including the Haynesville and the Permian Basin. Third-quarter production increased 23% sequentially and net income rose 9% to $168.5 million. CEO Tom Carter expects follow through. “We are excited about the momentum going into the fourth and next year,” he said on the third-quarter earnings call. He backed this up with huge insider buying on stock strength, a bullish signal in insider buying analysis.
- Dividend yield: none.
- Market cap: $1.6 billion.
- Insider buying: A large owner bought $11 million worth at prices up to $30.34 in November.
Tidewater Inc. TDW, +2.83% rents vessels for offshore production and development. The inside buying was by a investor named Robert Robotti who is a solid energy sector analyst, in my experience. Sequentially, third-quarter sales grew 17% to $192 million, in part because of an acquisition. Pricing and fleet utilization improved. Free cash flow also turned positive.
“The offshore vessel industry had reached an inflection point,” said CEO Quintin Kneen on the third-quarter earnings call.
Michael Brush is a columnist for MarketWatch. At the time of publication, he had long positions in EP and NFE. Brush has suggested EP, NFE, ET, TPL, CRK, BSM and TDW in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.