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Another nice month for energy. July 2023 saw Diversified Energy (S&P 1500 Energy, S15ENRS) advance +7.9% with subsector performance as follows - Oilfield Services +19.5% (OIH), Upstream/E&P +11.0% (XOP), Midstream +5.9% (AMZ) and Clean Energy −0.7% (ICLN). Energy nicely outperformed broader markets in July (S&P500 +3.2%, Nasdaq Composite +4.1%)..while still lagging noticeably YTD. Oil rallied to almost $82/bbl (+15.8%) and natural gas was relatively benign at only −5.9% (~$2.63/mcf).(1)
Oil’s rally was strong, but most interestingly, it was quiet. The market has spent most of its time focused on technology stocks, Q2 earnings, declining inflation indicators and interest rates. Meanwhile, a weaker dollar, the still resilient economy (which means record oil demand) and OPEC cuts are starting to play out. Inventory levels have not yet made meaningful moves lower. We expect they will. If front month WTI can rally to $80+ without that clear signal, does it portend even higher levels when the bullish oil story gets even more obvious? Perhaps. Encouragingly, longer dated oil also had a strong July and calendar 2025 WTI is ~$71.90/bbl (+9.7% during the month).
One specific headline to navigate later this year will be Saudi eliminating its temporary 1mmbopd supply reduction. But why prematurely rain on the parade?! Oil is finally acting more consistently with 1) a stock market that is trying to dial in a soft landing/no recession scenario and 2) expected bullish supply/demand fundamentals. Our $80/bbl 5-year forecast is unchanged…and will stay unchanged even if near term prices fall to $60/bbl or rise to $100/bbl. Yes, a recession would put a damper on things in the near term and skyhigh prices would crimp demand (and the economy), but $80/bbl feels like the right long-term average price that balances supply and demand.
Looking to natural gas, it’s worth a revisit of European prices. This time last year, European TTF prices were ~200€/MWh (or about $65/mcf). Today they are ~27€/MWh (~$9/mcf) with European storage at normal levels. Amazing how the market takes panic and high prices and finds a solution. While another European energy crisis feels unlikely for winter 2023, we still believe it will be 2-3 years before Europe is out of the woods with international supplies sustainably offsetting Russian volumes. Thus, the global race to supply incremental LNG continues. During July, NextDecade announced the final contracts and go-ahead decision for its Rio Grande LNG project in Brownsville, Texas. This massive project has offtake contracts for 92% of nameplate capacity, will cost $18+B and deliver ~18mmtpa (~2.3bcf/day) when it is commissioned in 2027+. Costs and customer contract terms for Rio Grande were more onerous than the market expected, resulting in a NEXT stock price decline of −34% since announcement (−27% on the day announced). Sometimes, in a game of huge investments and long time frames, even when you win, you lose. European prices (and the optionality for future price spikes) still look wildly attractive to US producers who see US NYMEX futures priced under $4/mcf through 2025 (with a $2.63/mcf spot market today). EOG Resources and Apache both committed volumes to export, as did EQT in late July (1mmtpa / ~130mmcf/day) via Energy Transfer’s Lake Charles LNG facility.
Earnings season felt ho-hum for the big international oil & gas companies. With commodity prices down, Q2 results are lower y/y, which is always a tough dynamic in the battle for investor mindshare. European majors are somewhat shrugging off their green persona and pushing back toward parity with US-based brethren. BP, Shell and Total are all tweaking their oil/gas capital spending plans higher, with incremental focus on share repurchase and/or return-of-capital. Chevron pre-announced positive earnings on Monday, July 24th. The cynic in us says it was to avoid the competition of reporting the same day as Exxon, thus ensuring the Chevron CEO could get some CNBC time. For July, the five majors (excluding dividends) gained +3.3% (XOM −0.5%, CVX +3.9%, Shell +1.8%, BP +5.5%, Total +5.5%). Notably, more than half of this performance came on the last day of the month as oil pushed toward $82/bbl. Is that rotation we smell in the air?
On the fundamental front, US rigcount is now down -15% from its peak in November 22 and has fallen in 9 of the past 10 weeks. We’ve spoken about the compression in drilling economics that occurred as commodity prices moderated earlier in the year and well costs remained high. At 2021 costs of ~$700/ft, well-level returns in the Permian's Midland Basin at $80/bbl are ~80% . At early 2023 costs of $1,000/ft, the returns compress to just under 20%. Add on acreage costs, corporate overhead, debt service, E&P’s commitment to capital discipline and the fact that oil has been hovering around $70/bbl for most of the year and it should be no surprise that activity levels are softer. Oilfield service pricing has also eroded. Where from here? Oilfield service companies have guided to an activity trough in Q3, with a rebound in Q4. In a flat $70-$75 oil price environment, this would be a fantasy as 1) the economics wouldn’t justify increased activity and 2) there is no growth-driven urgency for US E&Ps to spend any excess budget. With increased oil prices, perhaps the OFS industry call for a Q3 trough will be accurate. In a status quo environment, US land activity will be blah (a technical term) for the remainder of the year.
Virtually every month in 2023 has seen some sort of interesting or meaningful consolidation activity. July 2023 was no different as Exxon and Denbury Resources agreed to merge. The rationale for Exxon was simple – Denbury’s extensive network of CO2 pipelines and storage assets could relatively quickly/easily be integrated into Exxon’s carbon hub strategy at a price tag cheaper than re-creating/building the assets. At ~$4.9B, a solid bolt-on for Exxon and a nice example of buyer discipline as they paid less than a 5% premium for DEN and well below where Denbury’s stock traded last October when rumors of a potential deal emerged. Why would Denbury sell? Building out a comprehensive carbon capture business is complicated and expensive. It is exactly the type of project that big oil companies are built for and exactly how small/midcap companies get overwhelmed. A good deal for both sides in the long run in our opinion.
Energy stocks had a great month in July. While oil didn’t get much headline attention until WTI broke $80/bbl, energy stocks were paying attention beforehand and rallied strongly (S&P1500 Energy +7.9%). YTD performance is barely positive (+2.2%), but it is always better to be making money than losing money! Technology earnings have been mixed (Google good, Microsoft weak, Meta strong, Netflix weak). On the margin, this probably means there is some money looking for a new home. The last day of the month saw Exxon and Chevron both rally ~3% on above average volume. Way too early to know if this is a real rotation or just frenetic trading behavior. And we must also realize we’re enjoying a rally that was catalyzed by (and therefore somewhat dependent upon) stronger oil prices. We’ll take it, but we’ll also watch it carefully.
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