Home Commodities Falling oil prices and recession fears are halting growth in US oil and gas

Falling oil prices and recession fears are halting growth in US oil and gas

by SuperiorInvest

A two-year rally in U.S. oil and gas inventories is stalling as falling oil prices and fears of a slowdown in the world’s largest economy threaten producers’ ability to keep payouts to shareholders.

The S&P 500 Energy Sector — consisting of oil and gas group — was the market’s top performer in 2021 and 2022, rising more than 50 percent last year as Russia’s sweeping invasion of Ukraine boosted oil prices and operators used the windfall to repair balance sheets and shower shareholders with cash.

Sentiment has changed, with the energy sector down 5 percent year-to-date, compared with an 8 percent gain in the broader market and a 24 percent gain in the technology sector.

Investors are bracing for a recession and are worried about a weak “macro backdrop” that could trigger another drop in oil prices, said Matt Portillo, head of research at consultancy TPH&Co. “It doesn’t inspire much confidence in the near-term future of cash flows.”

U.S. crude settled at $71.34 a barrel on Friday, well above its long-term average but still down 7 percent this year as turmoil in the U.S. banking sector roiled markets.

The stocks The selloff came despite companies reporting another strong quarter of cash flow and shareholder payouts in recent days, part of a new operating model in a sector that had become notorious for burning investors’ cash on reckless drilling sprees over the previous decade.

“These companies had high stock prices when they were in losses,” said Trisha Curtis, CEO of consulting firm PetroNerds. “Now they’re making money and not being rewarded.”

Wall Street’s lingering skepticism remains visible in the valuation of the S&P 500’s energy sector’s dividend yield — still double that of the financial sector and four times that of the technology sector.

Some investors say shale companies are suffering from a two-year surge in share prices, as major shale operators such as Devon Energy and Pioneer Natural Resources began paying “variable” dividends, including a basic dividend and an extraordinary cash-flow-based payment.

“Stocks tend to be pace-of-change stories, and last year, with commodity prices going up, you had a positive pace of change in terms of free cash flow generation and return on capital,” said Mark Viviano, portfolio manager at Kimmeridge. , an activist private equity group.

But falling commodity prices have triggered a “reverse effect” this year, Viviano said, prompting investors to worry about a cut in the variable dividend.

Devon was the first shale producer to introduce a variable dividend in 2021, nearly doubling its share price to become the top producer in the S&P 500. Since it began cutting the variable portion of its dividend in November, the stock has lost nearly 40 percent of its value. The company is expected to report another strong quarter of earnings on Tuesday.

% line chart showing shale dividend yields rising again

Weaker operating conditions, including rampant oilfield service cost inflation and declining productivity, also weighed on companies as oil prices fell, Portillo said.

Even in the prolific Permian Basin in Texas and New Mexico, production from each new well drilled has fallen nearly 30 percent over the past two years, according to the Energy Information Administration.

“An estimated 30 to 40 percent increase in the cost of field operations, increased interest charges on borrowed money, a drastic drop in natural gas prices combined with lower oil prices have created noticeably lower cash flow,” said one anonymous executive at Dallas Federal. The latest quarterly survey of the US oil patch Reserve.

Forward price-to-earnings line chart showing that investors continue to discount oil and gas stocks

Analysts say environmental, social and government movements also continue to influence Wall Street’s view of fossil fuel producers — and their long-term value, given the government’s push to accelerate the energy transition.

“The market and investors are still uncomfortable with oil and gas,” Curtis said. “Companies are not valued by their assets or what they produce.”

Other analysts say capital markets skepticism will continue to discourage spending, contributing to the coming rise in oil prices as supplies fall short of rapidly rising demand – the so-called supercycle thesis, which predicts the onset of a multi-year oil bull market.

The International Energy Agency said last month that global oil production will grow much more slowly than demand in 2023, setting another record later this year.

But analysts say equity investors are now more focused on bearish signs of a slowdown in the U.S. economy, where diesel consumption — often a leading indicator of industrial activity — has fallen 20 percent since February last year, according to the EIA.

Only when the clouds over the world’s largest economy clear and global oil markets begin to pick up will energy stocks find favor again, analysts say.

“We have to get over the recession fears — next week, next month or whenever — and then. [global oil] inventories have to come down,” said Christyan Malek, global head of energy strategy at JPMorgan.

“The thesis of a supercycle in the medium term remains intact. But demand is currently the king of the energy complex,” he added.

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