The view from PV Mexico - Nov 20

The view from PV Mexico - Nov 20

Postby dan_s » Sat Nov 20, 2021 8:55 am

This is our last full day in Puerto Vallarta (sad). I will be back at my desk on Monday. It has been a rough week for upstream companies but oil and gas prices remain high and I don't see much chance of supply exceeding demand anytime soon. I also see the possibility of OPEC+ running out of spare capacity sooner than expected. No podcast this weekend.
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Devin McDermott – Morgan Stanley
November 19, 2021 1:47 AM GMT

Rising commodity prices and pervasive capital discipline have supported E&P's ~90% YTD rally. We see this shift in capital allocation away from growth toward FCF as structural, a dynamic that should support a re-rating in currently discounted valuations & higher medium-term oil & gas prices.

A record year for E&Ps, with more room to run. Despite a volatile start to November, E&Ps have risen ~90% so far in 2021, the best performance since the inception of the S&P1500 E&P index in 1995. This strength has been supported not only by rallying commodity prices but by pervasive capital discipline across the sector. The combination of rising margins and lower spending has led to the industry's best FCF in decades, underpinning a wave of new cash return commitments to shareholders. Looking ahead, we think this shift in capital allocation away from growth toward FCF is structural, a dynamic which should support a re-rating in currently discounted valuations and higher medium-term oil & gas prices.

We are refreshing our estimates for 3Q earnings, raising our long-term commodity assumptions and price targets, and revisiting oil price sensitivities across our coverage. Sensitizing our estimates for a range of oil prices in 2022+. At our base case of price deck of $70 WTI in 2022, our oil-focused E&P coverage offers a median FCF/equity yield of 17%, 3x the S&P 500. This would rise to 21% at $80, but also still remain fairly attractive should oil move lower (13% median at $60 WTI).

BUYS: OW-rated OVV, FANG & COP offer compelling combinations of FCF yield, valuation, leverage and cash returns, while EW-rated DVN & MRO also stand out. At higher oil prices ($70-80+), OW-rated OXY offers outsized rate of change.
> $60/bbl WTI: In 2022 we estimate median FCF/equity yield of 13%, FCF/EV yields of 9%, net debt/EBITDAX of 0.9x, and EV/EBITDAX multiples of 5.1x.
> $70/bbl WTI (Base Case): Assuming $70/bbl WTI, in 2022 E&Ps offer a median FCF/equity yield of 17%, FCF/EV yields of 12%, net debt/EBITDAX falls to 0.6x, and EV/EBITDAX multiples of 4.2x.
> $80/bbl WTI: We see 21% median 2022 FCF/equity yield, FCF/EV yields of 14%, and 0.4x median net debt/EBITDAX, and EV/EBITDAX multiples decline to 3.5x.

Updating our estimates for 3Q results (see Growing Cash Returns, Not Production) & raising price targets for higher commodity prices. Specifically, we are increasing our long-term WTI oil price assumption to $67.50/bbl from $57.50, consistent with Morgan Stanley Oil Strategist Martijn Rats's updated views.

We also incorporate our higher LT Henry Hub gas price assumption of $3.25/mmbtu, up from $2.75 before (see Assessing the 'New Normal' — Stronger for Longer?). These changes drive our price targets 17% higher on average, with stronger margins partially offset by inflation-driven increases to our capex estimates. On average, our valuations imply ~35% upside from current levels.

We continue to see an attractive setup for the industry into 2022. Intrinsically, we estimate the sector is pricing in ~$59/bbl WTI, well below the 12-month forward strip (~$75) and our strategist's long-term forecast ($67.50), creating room for a further catch-up trade versus the commodity. Heading into next year, we expect cash returns to remain a key driver for stock performance. That said, rising inflationary pressure should make operational execution increasingly important. Against that backdrop, we are focused on stocks with strong FCF/EV yields and scale to better manage inflation risks, as well as select rate of change stories.

Reshuffling Gas E&P ratings: Overall, gas E&Ps screen cheaper than oil producers at strip prices (median FCF yield of 19% and multiple of 3.5x vs. oil peers at 17% and 4.2x). That said, we see downside risk to Henry Hub prices into next year at normal weather (MSe $3.75 vs strip at ~$4.25). Against that backdrop, we prefer exposure to more hedged gas producers that have lagged through the recent rally:

> Upgrade EQT to OW: EQT has underperformed gassy peers by ~80% YTD as
below-market hedges weighed on near-term FCF and investors tilted towards
more liquids-exposed names. That said, we see EQT's FCF/EV expanding from
~13% in 2022 to 16% in '23 as hedges roll off, well above the gassy E&P median
(ex-EQT) of ~10%. We expect this strong cash flow profile to support
meaningful cash returns, with the company's upcoming shareholder returns
announcement (expected before year-end) a key catalyst.

> Downgrade RRC to UW: RRC has been one of the best performing gas focused
E&P, rallying ~240% YTD and outperforming peers by ~130%. That said, after
this strong performance RRC screens more expensive at a '22 FCF/EV yield of
~12%, below peers at ~14%, while also trading at the high end of the group on
EV/EBITDAX valuation at 3.7x in 2022 compared to peers at 3.3x.

> More attractive options for NGL (natural gas liquids) exposure include AR & OVV.

Key Stock Picks: In addition to our EQT upgrade, our key E&P stock picks include FANG & OVV (peer-leadingFCF with near-term inflection to higher
cash returns), OXY (differentiated rate of change + low carbon strategy), and COP (more defensive "quality on sale"). Within Integrated Energy, SU
remains our Top Pick.
Last edited by dan_s on Sat Nov 20, 2021 11:35 am, edited 1 time in total.
Dan Steffens
Energy Prospectus Group
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Posts: 27309
Joined: Fri Apr 23, 2010 8:22 am

Re: The view from PV Mexico - Nov 20

Postby dan_s » Sat Nov 20, 2021 9:25 am

Carbon capture plays prominent role in latest Gulf lease auction. S&P Global.
Carbon capture and storage played a large role in Lease Sale 257, which recorded a bumper crop of bids from oil and gas producers Nov. 17 for drilling rights in the US Gulf of Mexico. Of the 317 bids the Bureau of Ocean Energy Management received – the highest since 2014 – about 140 of them were for tracts located in shallow waters of the Texas and Louisiana coast, inexpensive areas with depleted oil and gas reserves.

December natural gas futures find new footing amid export demand strength. NGI.
Natural gas futures vaulted higher on Thursday as production eased, export demand jumped, and traders looked ahead to colder weather and the onset of winter storage withdrawals. The December Nymex contract rose 8.6 cents day/day and settled at $4.902/MMBtu. January added 8.1 cents to $4.995.

US oil, gas rig count jumps 11 on week to 683; Permian sees double-digit growth: Enverus. S&P Global.
The US oil and gas rig count jumped 11 to 683 in the week ending Nov. 17, Enverus said, with the Permian Basin of West Texas/New Mexico posting an even larger increase in rig activity. The domestic oil rig count rose by 16 to 541 for the week ended Nov. 17, while the natural gas-directed count fell back five to 147. The Permian, the largest US producing basin at 4.78 million b/d of oil and a 13.4 Bcf/d of gas, according to S&P Global Platts Analytics, added 12 rigs for a total of 284, reaching its highest count since mid-April 2020.
Dan Steffens
Energy Prospectus Group
dan_s
 
Posts: 27309
Joined: Fri Apr 23, 2010 8:22 am


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