After the pandemic economic shutdown decimation of oil/gas stocks in 2020, rumors and questions about the future of the two largest U.S. integrated energy giants are swirling everywhere in early December. Exxon Mobil (XOM) and Chevron (CVX) have announced assets sales, restructurings, lay-offs and write-offs. They have tried to lower operating expectations and guidance numbers for the next few years. Dividend cuts could be next, hurting investor values and interest. Wall Street bearishness and pessimism are now conventional wisdom after a decade of stagnation to lower pricing for the whole oil/gas industry. Some analysts are even suggesting the two should merge operations.
But here’s the good news for forward thinkers. Natural gas and crude oil prices bottomed many months ago. And, the type of pessimism and disgust the average investor now feels for the oil/gas sector is what makes a lasting long-term low in equity pricing. The press releases and downgraded 2021 outlooks from each of the major integrated-energy conglomerates is another plus. Often, individual stocks and whole sectors reverse course after bad news is aired in public. So, if you want a high weighting in both of the former Standard Oil leaders, and some exposure to the remaining top oil & gas choices in one decision, the Energy Select Sector SPDR ETF (XLE) was designed for you.
Oil & Gas Moving Higher
Low and behold, the oil/gas stock quotes have risen from the dead since November. I have been arguing an oil sector bottom was close at hand for months with a positive long-term view of Exxon expressed in an article here during October, and a bullish take on the iShares U.S. Oil & Gas Exploration & Production ETF (IEO) here in early November. I have been bullish on natural gas names for some time, including an explanation to buy Cabot Oil & Gas (COG) in September here and CNX Resources (CNX) in October here. And, many of my regular readers know I wrote a slew of bullish reports on a number of energy names during and right after the crash lows in March-April. I rate all the energy stocks mentioned in past 2020 articles as buys or holds presently.
Below are 1-year price and volume charts of daily trading in crude oil and natural gas using the nearest futures products in New York. I have included several of my favorite momentum indicators to compare and contrast. Basically, rising trendlines are desired indications of underlying buying pressure. The Accumulation/Distribution Line, Negative Volume Index and On Balance Volume creation have been reported more of a mixed bag, than a screaming buy situation. The clear bright spot for futures trading has been strength in the Negative Volume Index, highlighting little overhead supply on slower volume days. This measurement also signals buying on weakness over time.
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A changing supply/demand dynamic in favor of tighter supplies looks to be fast approaching, if the coronavirus pandemic chapter in our lives can be closed in early 2021. Many analysts and economists, including famed investor Paul Tudor Jones, are predicting a boom in the economy during the summer (I am not), after the COVID-19 vaccinations are distributed. If this is our future, crude oil and natural gas demand could be high enough to increase energy prices markedly into the autumn of 2021.
The current U.S. Energy Information Administration forecast has crude oil returning to supply/demand balance globally by June. The output vs. consumption level of late 2021 is expected to roughly equal the 2018 level. Of course, the next several quarters of coronavirus-affected consumption will be the biggest variable for oil/gas to overcome.
A second macroeconomic trend of a weakening U.S. dollar currency should also prop up commodity prices. Crude oil and natural gas could both zig-zag dramatically higher next year, enriching investors willing to buy and hold the industry today. Below is a chart of the fading U.S. Dollar Index since March, a measurement of fiat currency exchange rates. When your local currency declines, commodities tend to increase when priced in the devalued currency, as they are stores of value across international markets. I have talked about excessive money printing worldwide to fight the pandemic slowdown, especially by the U.S. Federal Reserve, as key to igniting commodity inflation sooner, rather than later. At some point, we may all realize the “free” money stimulus giveaway by Uncle Sam, financed by Federal Reserve money printing, will have serious consequences on the function, pricing and confidence in our economy.
Any way you mix and match the variables, a brighter U.S. price outlook for energy seems to be in the cards. Given the global long-term cost of production to keep output steady is likely in the US$55-60 a barrel range, crude oil prices above this level in the second half of 2021 are quite likely. And, already tight natural gas supplies leave little room for higher demand, without a substantial jump in price.
The Energy Sector SPDR may be a strong buy today, if oil and gas assets are embarking on a multi-year journey into an upcycle. The notoriously wild production and price swings in fossil fuels can cause total investor sentiment frustration at a bottom and euphoria at peaks. It appears we have crossed the Wall Street nadir in confidence during October-November.
XLE has $12.6 billion in assets under management, and charges a slight (compared to other sector ETF products) annual expense of 0.13% for running the fund. The best part of the buy proposition is its trailing divided yield is sky-high, at least before Exxon and/or Chevron potentially cut their payouts. Below is a 20-year graph comparing the XLE cash distribution vs. the SPDR S&P 500 ETF (SPY). Dividend slashes by others in the index has created a more realistic 5% yield expectation for 2021, as the ETF has lowered its latest payout level to around $0.53 each of the last three quarters.
For investors, the two safest integrated oil plays, based in America, account for 44% of XLE’s weighting today. Below is a graph of the Top 10 holdings as of November 30th. The blue-chip list includes Chevron, Exxon, ConocoPhillips (COP), Schlumberger (SLB), Kinder Morgan (KMI), EOG Resources (EOG), Phillips 66 (PSX), Williams (WMB), Marathon Petroleum (MPC), and Valero Energy (VLO).
Below are charts of the XLE ETF and the Top 10 holdings using the same setup and criteria for momentum indicators as the crude oil and natural gas graphs earlier in the article.
Again, the momentum indicators are not showing a high level of volume buying interest. What we have seen is a long-term change in sentiment, alongside a washout in selling the past month. From early November, the Top 10 have quietly enjoyed a resurgence in price.
If you are undecided about owning Exxon, Chevron, or a number of leading oil & gas blue-chips, why not own a basket of them in a single-decision ETF like the Energy Select Sector SPDR? Versus a low 1.6% dividend yield from the S&P 500, you can purchase an estimated 5% yield over the next year, likely to rise with a rebound in petroleum prices. The XLE looks to be a unique way to gain quick exposure to crude oil and natural gas equity investments, at low management expense.
I am planning to buy XLE on any material weakness into February. Purchasing the fund now is a solid idea, especially if you lack oil/gas ideas in your portfolio. However, a 5-10% off “sale” would be an even smarter mathematical construct for long-term ownership gains. A bigger than expected recovery in global demand could quickly rebalance supply/demand fundamentals and support a nice upswing in related equity values. I am modeling a $50+ XLE price in 12 months, up 80% from the October low point, given a slow, mild rebound in economic growth worldwide.
Thanks for reading. This article should be a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.
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Disclosure: I am/we are long CNX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am short SPY. I may initiate a long position in XLE, IEO, XOM, COG, EOG over the next 72 hours.
This writing is for informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. This article is not an investment research report, but an opinion written at a point in time. The author’s opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. Any and all opinions, estimates, and conclusions are based on the author’s best judgment at the time of publication, and are subject to change without notice. Past performance is no guarantee of future returns.