Energy Rally on Horizon

I was in San Antonio this past week giving a talk on the energy markets at the 13th Annual Value Forum InvestFest Conference. In fact, I am writing this on the flight home from San Antonio, reflecting on my presentation, the questions I received from the audience and some of my interactions with conference participants.

As I spoke to investors in San Antonio, I tried to convey three major themes.

One is that we are going to look back in about three years and think, “It should have been obvious that natural gas was a screaming buy at $2/MMBtu.” As I pointed out on one slide, the average monthly price for Henry Hub natural gas price has dipped below $2.50/MMBtu four times since 1999. Each time it did so, the price rallied.

In December 1999, the price fell to $2.36/MMBtu. One year later, in December 2000, natural gas peaked at $8.90/MMBtu.

In September 2001, the price fell to $2.19/MMBtu. A year later it had reached $3.55/MMBtu, and in February 2003 the price reached $7.71/MMBtu.

In March 2012, the price fell to $2.17/MMBtu, and a month later would drop to $1.95/MMBtu. In May 2013 the price was back over $4/MMBtu, and in February 2014 the average monthly price reached $6/MMBtu.

We are currently experiencing the fourth drop below $2.50/MMBtu. Natural gas first dropped below that level in October, and has trended down since. The monthly averages for December 2015 and February 2016 were respectively $1.93/MMBtu and $1.99/MMBtu — and this is where prices remain.  

Of course we all know the old adage about past performance, but there is another adage about the cure for low prices being low prices. And each of the previous three times we have seen gas below $2.50/MMBtu, the price more than doubled in less than two years.

If you are thinking this is just a seasonal issue, it isn’t. If you look at 2017 and 2018, current strip pricing on Henry Hub natural gas only varies about $0.30/MMBtu between the high and low price for monthly contracts in each year.

The second thing I stressed at the conference is that unless you are a short-term investor, it doesn’t really matter whether oil has bottomed. It could in fact make another trip to the lower $30s or even into the $20s. Then again it might not.

But what matters is that the current price of ~$35/bbl is below the price at which supply can continue to meet global demand. Right now there is a temporary global excess of capacity as the market rebalances, but once it does it won’t do so at $35/bbl oil. If you wait around until it’s clear that the excess supply is disappearing, you are going to pay more than you will today (and maybe a lot more).

The final point I emphasized is that the midstream MLP space is stupidly oversold. As with natural gas, there is some historical precedent. As I pointed out, on the few occasions over the past 20 years when the yield of the Alerian MLP Index — which is a heavily weighted toward the midstream MLPs — rose above 10%, a big rally ensued over the next 12 months.  

The AMZ yield exceeded 10% in December 1999, and the next 12 months saw a total return of 46% for the index. The yield again rose above 10% in December 2008 as the energy sector crashed, and the following 12 months notched a total gain of 76%. The AMZ yield once again topped 10% in mid-January and mid-February of this year, but it has since pulled back to 8.7% as the sector has rallied.

Those were the major themes I tried to drive home as I spoke with investors in San Antonio. This talk was a bit of a warm up for this year’s Investing Daily Wealth Summit, which will be held in Las Vegas in May. If you haven’t signed up, it’s not too late to do so.

The energy sector has certainly taken a beating since mid-2014, but I believe it is now presenting opportunities that come along only two or three times a decade. That’s the view from 30,000 feet above the Permian Basin.

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