We utilize our key driver framework to identify opportunities in the market where strong company level fundamentals such as Pricing Power, Capital Returns, or Market Position more than offset a horrible industry climate. We zero in on the Natural Gas sector as deserving of a closer look.
As contrarian-minded investors, we seek to find opportunities during periods of disruption, and during this current period we turn our focus to the Energy sector. The Energy sector has been the most downtrodden in the wake of COVID-19, the worst performer over the last year, and the only sector to register negative stock price performance over the last 5- and 10-year time periods.
We used the Insights Platform to sift through the negative sentiment in a search for instances or themes of positivity in this beaten down group.
Within Amenity’s Key Driver framework, we used the Headwinds/Tailwinds score (which is designed to capture sentiment related to business conditions) as our gauge of general industry sentiment. Limiting our screen to names with a negative Headwinds/Tailwinds score, we proceeded to sort by companies that registered a positive Amenity Score, which factors in all Key Drivers. The purpose of the exercise was to isolate companies whose positive scores in key driver categories such as CapEx, Capital Returns, or Market Position more than offset a horrible industry climate:
The energy components of the chart above are disparate in that they represent the Exploration & Production (E&P), Midstream and Oilfield Services verticals, but they are the same in that they all performed terribly versus the market over the last year. However, 2020 has been a different story for Cabot Oil & Gas, EQT Corp., and Range Resources, which have advanced 14-29% year-to-date. With vast and highly productive resource bases primarily in the Marcellus shale play of the Northeast, sentiment has made a positive turn of late for these E&P companies.
While investigating the dynamic underlying the recent outperformance, we uncovered some interesting industry trends in the Natural Gas sector and Energy more broadly. As the oil shale boom soared to new heights over the last several years, Natural Gas Liquids (NGLs) but especially natural gas itself became a byproduct. Producers were after oil, but prodigious amounts of natural gas and NGLs were extracted along with it — these associated hydrocarbons are little more than a nuisance to many shale basins, and pricing for them became depressed as a glut built.
However in the Marcellus, the primary output is natural gas and NGLs. With the recent rapid and nasty decline in oil prices (albeit improving of late), new oil drilling in North America has ground to a halt and substantial existing oil production has been shut-in. Output levels of natural gas and NGLs have declined and pricing has improved. The outlook for natural gas has been more upbeat lately, and the picture has turned more rosy. Dan Dinges, CEO of Cabot Oil & Gas, articulated this point on the company’s latest earnings conference call:
While the recent increase in the forward curve for 2021 is extremely positive for us, we believe that the market is currently underestimating the potential undersupply of natural gas markets entering into 2021, providing us optimism that the forward curve for 2021 will need to move higher to incentivize increased activity levels to address the undersupplied market.
Given their low cost of extraction, Marcellus players are able to generate cash flow and returns on natural gas and NGL production at lower pricing than oil-focused companies. This value proposition was articulated by Range Resources on their most recent conference call:
...we really don't see the need or benefit to return to high growth. So prices are significantly higher, we're generating significant free cash flow.
With our 2020 capital program, we will maintain operations with one drilling rig and one frac crew through year-end and are well positioned to continue maintenance operations throughout 2021, if needed, with an associated drill and complete capital similar to 2020, all while maximizing the utilization of existing infrastructure.
But most energy companies are saying all the right things these days… that they are focused on returns and free cash flow, and not on production growth. We have seen increased capital discipline, less aggressive drilling programs, and even some small capital return programs come to fruition. However, it can be difficult to determine who is following this path with success, as well as who has the assets and capital structure capable of acting in this manner over the long-term.
Some companies and/or basins should emerge from this downturn with certain structural market advantages. We feel that EQT Corp. has separated itself from the most E&P companies in this regard. The following extraction regarding their land position, taken from their most recent earnings conference call, exhibits their strong market position within a basin whose prospects are brightening:
And then looking forward in future years, 2021 going forward... one of your points, you referenced with a stronger 2021 outlook for gas, has that impacted land? I'm reading through into thinking about competition. And I would just say that with such a dominant foothold that EQT has, along with just the mature aspect of this basin, we really haven't seen a lot of competition here. And really in any part of the play, there's only one operator that can give landowners the confidence to get a wellbore drilled and get royalties, which is the big prize. And landowners are definitely educated and understand that and are willing to work with EQT. So that's sort of the dynamics of land right now
The dynamics of the natural gas and NGL market have changed with the recent pullback in oil drilling. Gas and NGLs will remain in the background for oil-focused basins, which is compounded by lower overall activity. This shift opens a new window for some Marcellus players, and for now this structural shift has led to an inflection pointed toward increased strength.
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This communication does not represent investment advice. Transcript text provided by FACTSET and S&P Global Market Intelligence.
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