Eric Nuttall's Top Picks: Baytex Energy, WPX Energy and Parsley Energy
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MARKET OUTLOOK
Recent months for energy investors have been challenging, testing even the strongest of stomachs with gut-wrenching volatility driven by global macro worries (weakening data points from China and the Asian country’s trade tensions with the U.S.), a confusing OPEC policy (a surge of 1.8 million barrels per day from May in Saudi Arabia, the United Arab Emirates and Russia in anticipation of Iranian export reductions), erratic behavior and policy changes from the White House (from driving Iranian exports “to zero” to issuing waivers to eight importing countries), and surging production from the U.S. and other areas (production in the Lower 48 being up 1.3 million barrels per day year-to-date, while in Libya it’s up 0.4 million barrels per day from the summer).
Net speculative length in Western Texas Intermediate (WTI) and Brent Crude has fallen to multi-year lows. Generalist investors have shunned the space while algorithmic and quantitative funds have continued to press their shorts in a weakening and increasingly illiquid tape, which is now beholden to a buyers’ strike and the largest amount of tax-loss selling in years.
Are fundamentals as bad as a $50 WTI and stocks being down 30 to 50 per cent year-to-date would suggest? Not by a long stretch. While softening demand growth has likely delayed our more bullish view on crude by about one year, we still believe oil to be in a multi-year bull market and that WTI will trade back at $70 per barrel sometime in 2019. Lower temporary oil prices will act as a demand boost and will also negatively impact U.S. shale growth in 2019. We think compliance to the 1.2 million barrels per day cut will be high; the reality is that the cut may be higher than advertised (Saudi Arabia is cutting January production by 0.9 million barrels from November). The world is now only one year away from the non-OPEC and U.S. production cliff after which the group’s production will begin to fall for at least four or five years as the impact of the largest drop in spending on long-lead mega projects begins to be felt. At the same time, global energy demand will continue to increase for many years and by extension oil demand will continue to grow for the next several decades (well beyond the capacity of U.S. oil shale to satisfy it).
Alberta’s mandated shut-ins combined with a ramp in crude-by-rail (over 450,000 barrels per day exiting in 2019) and with Line 3’s in-service date anticipated for the fall, we should see Western Canadian Select (WCS) differentials stabilize at $20 per barrel until either TMX or Keystone XL come online around 2021. Light oil (MSW) and condensate differentials have also materially fallen, helping Canadian producers weather the temporary storm.
While energy stocks have fallen much more than I ever thought possible given a softened but still bullish macro outlook for oil, we feel alone in our call that energy stocks offer a “generational wealth-creating” opportunity. Many stocks that were once viewed as “uber high quality” have fallen by 50 per cent in the past six months. The market isn’t distinguishing between quality and junk. Several energy stocks are significantly lower today than when oil traded at $26 per barrel. Sentiment is the worst I’ve ever seen in my career and the sector is being completely shunned as energy stocks experience merciless tax-loss selling. If one believes only in a $60 WTI, energy stocks offer over 100 per cent upside from current levels. We remain bullish.