OPEC, Trump agenda weigh heavily on minds of energy investors

Many energy companies have posted increasingly positive earnings reports in recent weeks, but energy stocks remain sluggish. This raises the question: What will it take for them to gain ground? 

The strong performers have included super-majors, like ExxonMobil, large independents, such as Apache, and smaller independents. In some cases, these reports show growth in earnings; in others, it’s substantial reduction in losses.

{mosads}ExxonMobil, for example, posted first-quarter earnings that are 30-percent higher than the year before and earnings per share rose 121 percent, but its stock is down about 7 percent.

Apache Corp. announced Thursday that, in the first quarter 2017, they returned to profitability with GAAP earnings of $213 million and adjusted earnings of $31 million. Additionally, they reported closing on $466 million of non-core asset sales, as well as delivery of first gas at Alpine High midstream, two months ahead of schedule. By early afternoon, their stock rose from an opening dip, but is below its level of a week, month and year ago.

Of course, not all companies have such favorable news to report. Some even now are entering bankruptcy proceedings, while others are emerging into a more favorable, if not robust, price environment.

Why, then, is the market holding back?

The industry, in many cases, was slow to respond to the collapse in prices that began in 2014. They hoped that it would be as short-lived as the 2008-09 downturn. Some even saw it as an opportunity to poach staff and assets from companies they saw as panicking. But as prices stayed lower for longer than many executives initially expected, the response was fierce.

Staff was laid off, capital budgets slashed and operations curtailed. Companies focused on cash flow, debt service and survival. The impact, in many cases, was magnified for the service companies and equipment manufacturers.

Investors like the signs they have seen recently, but are holding back until several key questions are answered concerning OPEC, strategy, finance and politics: 

1. Will OPEC maintain their cuts when they come up for renewal in June? As the rig count and oil production in Texas’ Permian Basin rises, will participants in the current agreement — both OPEC and other major producers, like Russia — conclude they are supporting prices for the benefit of American producers to their own detriment?

In 2014, U.S. producers counted on OPEC to cut production to stabilize prices and were shocked when the cartel broke from perceived tradition. A free fall in prices followed at the end of November. Will these non-U.S. producers now opt for a lose/lose approach?

A unique mitigating factor discussed in oil circles is the much-anticipated Saudi Aramco initial public offering (IPO). Won’t the Saudis do everything possible to maintain oil prices to justify confidence in their IPO?

2. A number of companies have dramatically shifted strategy. How well will these be executed?  Shell, for example, implemented its shift away from oil in favor of natural gas in its $70 billion acquisition of BG Group (formerly known as British Gas). This includes major assets in Brazil, which is just coming out of a massive financial scandal that impacted Petrobras, the national oil company, and much of the energy value chain as engineering and construction companies came under investigation.

In the case of Apache, a leading independent, a major discovery known as the Alpine High has reshaped its strategic plans. In the past, free cash flow from U.S. operations supported overseas ventures. Now, the reverse is true, and funds will flow back to the U.S. Can Apache overcome skepticism about its claims to a prize of 3 billion barrels of oil and 85 trillion cubic feet of natural gas? Additional work is underway to prove up these reserves.

3. Is there sufficient data to determine where in the long value chain the greatest returns will be? Several years ago, activist investors led ConocoPhillips and Marathon to break their integrated companies into separate upstream (exploration/development) and downstream (refining) businesses.

At the time, upstream was seen as the prize. As it turned out, the market performance of the newly created downstream companies was far better. Today, investors are often attracted to the petrochemical end of the value chain, with tens of billions of dollars in new investment along Houston’s ship channel.

Unlike previous recoveries, there is a tremendous amount of private equity available outside the traditional stock markets. Many investors prefer to fund new opportunities clearly focused on specific assets. Why buy companies burdened by accumulated debt and legacy assets?

Much of the current recovery is based on driving down costs, both in the companies’ own operations and by leveraging their suppliers. Can investors determine how much of the cost saving is sustainable (by drilling wells more quickly or in better defined “sweet spots”) versus pressuring suppliers who now are feeling market strength?

4. The Trump administration has taken a number of steps to support the industry, most recently in opening the Arctic and Atlantic coasts to drilling, reducing EPA restrictions and reversing Obama administration executive actions. But how much impact will these moves actually have in the near term as companies focus on lowest-cost production?

Finally, the specter of an indulgent energy industry haunts investors. “Please, Lord, give me one more boom. I promise not to mess it up this time.” Words to that effect are ominous. Will discipline continue in a $50 per barrel world, let alone if prices pass $60 toward year-end?

As we approach the midyear mark, it will be important to keep an eye on the outlined questions. It may not be until 2018 until we see some real takeoff. 

Bill Arnold is a professor in the practice of energy management at Rice University’s Jones Graduate School of Business. Previously, Arnold was Royal Dutch Shell’s Washington director of international government relations and senior counsel for the Middle East, Latin America, and North Africa.

The views expressed by contributors are their own and not the views of The Hill.