Weekend July 25, 2015
Puzzling Divergences in the Energy Sector
I’d say there is a big difference psychologically between $50 and $49.
Allen Gilmer, CEO DrillingInfo
The market for surface oil technologies in North America is stabilizing though it is unclear where it goes from here.
Charles Sledge, CRO, Cameron International
The prognosis assumes no significant change in market circumstances through yearend.
Bernard Duroc-Daner, CEO Weatherford International
A few weeks back we declared $50 to be the ‘line in the sand’ for oil prices. Oil is now trading within $5 of its previous low of $43.46 on March 17. But strangely, not all energy sectors are still declining. Let’s take a look.
Crude Oil futures trade for every month of the year on the New York Mercantile Exchange NYMEX. This morning September futures are $48.38 but December is trading at $50.13. So the near term is below $50 but four months out that level is still holding. Unleaded gasoline has fallen below its entire daily moving averages, which is negative. But at $1.81 on the close yesterday, it is well above the sub $1.130 level of January. Heating oil at $1.637 is less than a dime from its January lows.
Since the start of the year, crude oil has made two lows around $45. It appears headed for a third low in that area. Market technicians refer to this as a ‘triple bottom. ‘ Most triple bottoms do not hold resulting in lower prices.
Commodity markets typically have to go to such low prices that some producers are literally driven out of the market. Which is to say prices have to fall below the cost of production. This means only the strong balance sheets with lots of cash and low debt survive. Already Hercules Offshore, a Houston shallow water driller, will file for Chapter 11 next month.
The Saudis have higher costs today than in the past. And surely they view low prices as hurting their nemesis, Iran.
Market lows happen amid massive pessimism. The result is that such lows tend to be sharp and short-lived. The March 17 low is a good example. Amid negative sentiment, social mood turned on a dime and prices rallied to $61.
There are other signs of an eventual low. The basic accounting equation holds that Assets minus Liabilities equals Owner Equity or book value. When publicly traded firms fall to book value or below, assuming they have cash to sustain them selves through a loss period, such companies are a ‘Warren Buffet’ kind of buy. We have evidence that is happening now.
Let’s start with the majors. A price to book value ratio of 1 has a company trading at exactly book value. A value of say 1.03 means the firm trades for just 3% over book. With that in mind British Petroleum BP is 1.03, Chevron CVX is 1.12, and Conoco-Phillips is 1.37. And BP is paying a 6.2% dividend at this price.
Interestingly the pipeline companies seem to be registering lows after falling the last several weeks. Alerian MLP AMLP an ETF of some 25 Master Limited Partnerships has fallen from $19.35 to $14.97, now trading at $15.08. The fact that it is not falling with the price of oil suggests investors are seeing value. This is particularly so in light of the overall stock market drops this week.
Energy service companies are trading for lower values than energy producers, which is usually the case in a bear market. Price to book ratios include Patterson PTEN .86, Transocean RIG .38 (not a misprint, 38% of book even after write downs!), and Key Energy Services KEG at a mere .21. Key is trading at $1.32 a share, which is less than the $2 it hit at the 2009 Crisis Low. The big guys like Halliburton and Schlumberger are trading at twice book.
Eagle Ford producer Abraxas AXAS is trading fell to $1.69 yesterday close to my target of $1.50 mentioned on my weblog. At $1.88 today it is literally trading for book value.
Natural gas prices are in much better shape than crude oil. Natural gas needs a weekly close over $3 to get going. Devon DVN is trading for 17% over book and train wreck Chesapeake at a mere 58% of book value.
It is not too early for investors to start tracking their favorite energy or energy service companies. Warren Buffet has become legend for scooping up bargains when as he says ‘others are fearful.’ Look for strong balance sheets (lots of cash and low debt) with a long management history. There is a low coming for oil prices but no one rings a bell at the bottom.