Crude Oil: Eric Nuttall The energy market is clearly broken. The sector has posted double-digit negative declines in four of the past five years and investors have largely left it unable to stomach the OPEC and Trump-tweeting induced volatility. The result? Valuations have fallen to the lowest level that I have ever seen in my 16-year career. At an oil price ($60 WTI) modestly higher than the 2020 strip price, energy stocks are trading at over 10 per cent free cash flow yields and at discounts to their proved reserve values. We have holdings that are trading at 36 per cent free cash flow yields with 33 years of proven reserves. This is clearly not normal. Yet each day incremental buying dries up as investors struggle to explain how WTI can rally by 25 per cent year-to-date and still in many cases energy stocks are down on the year. The level of frustration and indifference is palpable.
The curative to this apathy will be the wide adoption of massive share buybacks by companies. With many stocks trading below their liquidation value(that is, the proved developed producing reserve value), management teams should immediately prioritize buying back their maximum allowable amount of shares outstanding as long as their balance sheets allow for it (that is, if debt to cash flow is about 1.5 times and buybacks are financed out of free cash flow).
We’re currently in the weakest period for oil demand (we’re in the refinery turnaround season), yet the weakest barrels of the year are trading at $55 WTI. When 6 million barrels per day of refining demand comes back online, a potential China-U.S. trade deal is announced, Iran waivers are potentially reduced, U.S. production growth disappoints due to the under-spending cash flow using a $50 barrel and Venezuelan production continuing to fall, where will the oil price trade to? At $60 per barrel, we see more than 100 per cent upside in many energy stocks, but this requires investors to care about the space again. This requires a modest rally in the oil price to $60, a lessening in the daily volatility and the demonstration to investors by exploration and production company CEOs that share prices trading below liquidation value is unacceptable and will be remedied by share buybacks financed by egregious levels of free cash flow.
BNN.ca Market Call Friday Mar 8th @ 1200ET |
