HOUSTON–(BUSINESS WIRE)–The energy sector has outperformed the S&P 500 by 146% over the last two years so investors often question if this cycle is about over. However, energy cycles typically don’t end until the capital investment cycle has peaked and this one has just begun. The economic cycle may create headwinds for energy stocks as a recession creates headwinds for all stocks, but we believe relative performance is more a function of the capital investment cycle. Reinvestment rates and upstream investment are at the lowest levels in years, which should continue to drive outperformance as global supply remains constrained. Major takeaways include:
Capital should continue to flow back into energy.
Low returns repel capital, making the paltry energy index weighting of the last few years seem completely logical. Conversely with increasing capital discipline, industry return on capital employed is back to levels comfortably above the cost of capital, and we see index weightings returning to historical levels as attractive returns continue to draw capital back into the sector.
We remain constructive on crude despite near-term uncertainty.
Global crude inventories are at the lowest point since 2004 when accounting for strategic reserves, OPEC+ spare capacity is limited, and global upstream investment costs have increased ~25% since 2020 despite limited increases in overall capital investment spending. This leaves us comfortable that the floor in crude is much higher than in past recessions. We see the potential for significant upside stemming from supply imbalances heading into 2023, particularly if China demand recovers to historic levels.
Stocks priced like the end of the cycle, not the beginning.
Energy sector relative multiples continue to languish near 30-year lows. Historically, energy sector relative multiples compressed after a period of sustained capital investment. The market appears to be pricing the end of the current cycle before it has even started. Despite outperforming the S&P 500 by 84% in 2022, S&P 500 Energy FCF yields are over 2x the market averages in both 2023/2024 despite lower commodity prices.
PEP Research Top Energy Stock Picks for 2023:
- E&P: FANG, AR, PR
- Oil Service: DO, HP, SLB
- Midstream: ENLC, PAA, AM
- Renewables: SEDG, NOVA
Pickering Energy Partners (PEP) is an energy focused financial services platform. Our expertise spans decades across the entire energy landscape. We’ve deployed over $16 billion across all energy sub-sectors. We are, at our core, trusted energy advisors, investors, and partners alongside our clients. Headquartered in Houston, Texas, PEP delivers an experienced, opportunistic team that aims to provide guidance and long-term value for clients while having a positive impact on the companies and communities that PEP invests in. For more information, please visit www.PickeringEnergyPartners.com.
Pickering Energy Partners LP (“PEP”) is an SEC Registered Investment Advisor. Affiliated PEP Advisory LLC (“PEP BD”) is a registered broker-dealer, member FINRA/SIPC. The following commentary is provided by PEP Research, a division of PEP Advisory LLC.
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