Another week on financial markets driven by U.S.-China trade headlines. It is getting boring and quite annoying to step away from the trading screens for five minutes and see the Dow Jones suddenly down 300 points on an unsubstantiated Chinese newspaper report. And even more annoying to see the Dow finish the day up 150 points (a 450-point swing) on White House denials of the Chinese newspaper report.
When the S&P 500 rises, energy stocks lag. When the S&P 500 declines, energy stocks plummet. This is not news. And any remaining bullish investors must be wondering if the energy sector nightmare will ever end.
Having witnessed the debacle in the energy sector since 2014, it is time to entertain the possibility that we are seeing more than just a horrid bear market in energy. We may be witnessing a structure shift within the energy sector. energy stocks, which are down -50%, -70% and some down -90% from their 2014 peaks, may have experienced a permanent impair in their share prices.
To put the energy sector catastrophe in perspective, the next chart shows the S&P Oil & Gas Exploration & Production Index (XOP), S&P Oil & Gas Equipment and Services Index (XES), and the S&P 500 (SPY) (base 100 at June 20, 2014). Yes, some sectors always lag in an equity bull market. But what energy has done is not just lag. There is something really wrong here.
And the problem is specifically in oil and gas, not clean energy, which has decoupled from the oil and gas companies.
More Than Just Headwinds
The structural problems for oil and gas, while not unknown, now appear to have been grossly underestimated by energy bulls. Many say that the hedge funds and short-selling algos are unjustly punishing energy companies. No, not true. At these valuations, the smart money would have already come in and scooped up most of these energy names, blowing the short-sellers out of the water. The fact that the big money investors have not jumped on energy stock is, in itself, a warning. We remind readers of the main factors pushing energy stocks to record lows on an almost daily basis.
1.) U.S. energy independence through fracking. It all comes down to supply and demand. And what has changed since 2014 is U.S. drilling. Growing stockpiles and growing inventories keep pulling down the prices of natural sas and crude oil. Energy companies cannot survive with current cost structures and the hit being taken on the revenue side.
2.) Waning Demand. At same time waning demand both due to a global economic slowdown and a move to clean energy sources. Many companies, aware of the importance of sustainability and ESG in their long-term business models, are getting ahead of the curve and already transitioning away from coal and gas.
3.) Fossil fuels are so 20th century. Long-term, markets are anticipating way out into the future. A future in which the combustion engine car will be a relic and all homes will be heated with alternative energy sources such as solar or geothermal. Most investors a few years ago, while recognizing the rise of clean energy, assumed that the day fossil fuels would no longer be the primary source of energy was so far off into the future that it would not impact current oil and gas investments. This may be turning out to be a bad assumption.
We also make an observation that we believe is quite pertinent. The S&P Utilities Index is soaring. Along with technology, utilities are one of the sectors driving the stock market higher. Since when have utilities been a late-cycle stock market driver!? We have a hypothesis. The move to cleaner energy is already happening under the surface. Energy investment dollars are going into utilities. Take a company like Pattern Energy Group (PEGI), classified as a utility. The company owns roughly two dozen wind power facilities and has several more in the pipeline as well. Dedicated to renewable energy practices, the San Francisco-based operation sells electricity and renewable energy credits to utility companies. Pattern Energy’s stock price is trading just off its 3-year high. Can’t say that for many GICS-classified energy sector companies.
We have a more radical vision for the energy sector than most analysts on the Street. We see massive consolidation occurring among energy companies in the next 5 to 10 years. Most oil and gas companies will go out of business or get bought out. Successful oil and gas companies will be those whose managers embrace the clean energy revolution and develop alternative energy products. The future of energy investing will be in “hybrids” – traditional energy companies which move quickly to develop alternative energy products. We’ll be highlighting these companies to our readers in the coming months. Readers of our Marketplace service, ESG Investments & Monitors, will receive our best alternative energy trade ideas.
9 Energy Stocks That Will Be Around For A While
Let’s be clear. Many of the companies in the XOP and XES index trackers will not exist in 5 years. Buying and holding either of these products is about the stupidest thing a reader can do for their portfolio long-term. At the same time, energy is out-of-favor and should provide a good contrarian trade (but not long-term investment). Investors who wish to buy some energy companies here need to make sure that the company is not of the fast-track to bankruptcy.
We went through our list of energy companies with shares trading on a U.S. exchange in order to pick out the most solid, low-bankruptcy risk companies. We screened out companies with a
- WMA Financial Score in the top 25% of Energy peers,
- Altman-Z score above the risk of bankruptcy threshold,
- Positive profitability,
- Positive expected growth rates for the coming year (or earnings getting revised higher)
Excluding the mastodons of Exxon, Chevron, BP, Total, and Royal Dutch, which are too-big-to-fail at this time, we share our Top 9 of “second-tier” energy companies that we would still be buying today.
CNOOC explores for, develops, produces, and sells crude oil and natural gas. It produces offshore crude oil and natural gas primarily in Bohai, Western South China Sea, Eastern South China Sea, and East China Sea in offshore China. CNOOC growth is weak (EPS growth expected to be slightly positive while revenue growth seen slightly negative) but pays a fat 6% dividend and the company is financially solid. The stock price reflects this optimistic diagnosis, up over 50% above 2016 lows. ESG-focused fund managers could include CNOOC in their ESG portfolios.
China Petroleum & Chemical Corporation (SNP)
China Petroleum & Chemical Corporation, an energy and chemical company, engages in oil and gas, and chemical operations in the People’s Republic of China. It operates through five segments: Exploration and Production, Refining, Marketing and Distribution, Chemicals, and Corporate and Others. China Petroleum completes, along with CNOOC, form our China Energy duo. Again, growth forecasts for China Petroleum are light, but the dividend paid is juicy. China Petroleum’s stock price has fallen, but remains above 2016 lows (unlike the XES or XOP). Also an ESG-friendly company.
Daqo New Energy Corp (DQ)
Daqo New Energy Corp. manufactures and sells polysilicon to photovoltaic product manufactures in the People’s Republic of China. We had to slip in this company producing modules for solar power solutions. This is a small cap company with greater risk, but financially the company is sound and we believe in the solar panel business. Compared to Oil & Gas firms, Daqo New Energy’s Growth rate blows most other energy companies away.
National Oilwell Varco (NOV)
National Oilwell Varco, Inc. designs, manufactures, and sells systems, components, and products for oil and gas drilling and production worldwide. A low-risk company with a stock price trading below 2016 lows. We still don’t think that the entire XES is attractive at current prices, but National Oilwell Varco’s stock is attractive.
Phillips 66 (PSX)
Phillips 66 operates as an energy manufacturing and logistics company. It operates through four segments: Midstream, Chemicals, Refining, and Marketing and Specialties. Phillips 66 is one of our holdings for energy exposure. Solid financially, Phillips 66 is among the most profitable energy companies. The stock price reflects this, trading about 30% above last December’s low. A great ESG-focused management as well.
Surgutneftegaz OAO (OTCPK:SGTPY)
Surgutneftegas Public Joint Stock Company explores for, produces, processes, and sells hydrocarbons. It operates through Exploration and Production, Refining and Sale, and Other Activities segments. Of the Russian oil companies, Surgutneftegas ranks higher in our system than Lukoil and Gazprom. Surgutneftegas is financially solid, trading at a good valuation, and pays one of the biggest dividends in the market.
TechnipFMC plc engages in the oil and gas projects, technologies, and systems and services businesses. It operates through three segments: Subsea, Onshore/Offshore, and Surface Technologies. TechnipFMC’s stock is likely getting held down by Brexit, in addition to the general energy sector weakness. We like TechnipFMC as a low bankruptcy risk energy sector recovery play.
Transportadora de Gas del Sur SA (TGS)
Transportadora de Gas del Sur S.A. provides natural gas transportation and distribution services in Argentina. This is another Energy pick whose stock price is beaten down due to geopolitical risks. There is nothing not to like about this company and the stock price. Slam dunk company in growth, value and a 21% dividend yield, according to WMA rankings . A back-the-trailer-up-and-buy stock for those who can stand emerging market geopolitical risk.
World Fuel Services Corp (INT)
World Fuel Services Corporation engages in the distribution of fuel, and related products and services in the aviation, marine, and land transportation industries worldwide. This is an energy services company whose stock is already in a healthy uptrend. Less-sensitive to oil and gas prices, World Fuel Services is a safe bet to diversify your energy portfolio.
We cannot get excited about buying the XES or XOP products. Each rally only becomes an opportunity for short-sellers to better attack energy companies that are heading for bankruptcy. Investors running energy portfolios should focus on specific, low-bankruptcy risk names that will survive this transformational period for the energy sector. Diversifying into energy companies less-sensitive to oil and gas prices, as well as companies active in green energy, will also solidify energy portfolios.
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