Note from Morgan Stanley Research Team 5/14/2018

[dan_s]

North America Energy: 2018 Energy Conference Takeaways

Divergence between some of the best corporate sentiment we've seen in years versus low investor interest highlights a clear opportunity in energy equities.
Service tightness, Permian takeaway constraints, and capital discipline remain key themes in the US.

Energy remains broadly under-owned. Corporates with heavy US exposure are
the most optimistic we've seen in years, while more internationally focused
companies (particularly services) were more measured. We got the feeling many
investors are constructive on crude price and general sector macro, but this has
not yet translated to meaningful buying outside of highly defensive stocks,
suggesting more to come in the recent rally.

US service pricing broadening across most product lines; efficiency the wild card
for E&P capex guidance and service margins. The service market remains robust,
with most product lines realizing high single-digit to low double-digit pricing
outside of pumping and frac sand. Yet, E&Ps continued to reiterate cost inflation
guides of 10-15% this year – we think efficiency will be the key swing factor to
both E&Ps hitting production targets within guided capex as well as services
realizing expected mid-year margin expansion.

Permian takeaway capacity remains a concern, though E&Ps are confident it can
be managed. Companies noted that it will likely be an issue until additional
pipelines come on-line in 2H 2019. While the companies we spoke with all had a
strategy to address the concerns, the level of clarity varied from company to
company. Relative to management teams, investors (particularly hedge funds)
were far more concerned about the impacts of takeaway constraints on price
realizations for producers and margin opportunity for refiners. Inside we include
our Permian takeaway model which suggests even wider Midland differentials as
capacity tightens further through 1H19. We also detail company exposure.

E&Ps remain confident that any Permian bottlenecks are manageable. Keeping with the
theme of first quarter earnings, infrastructure and takeaway issues are expected by the
industry to become prominent toward the end of 2018 and beginning of 2019. That said,
most E&P management teams remain confident that they have a strategy to deal with
any constraints, takeaway or otherwise. Though the level of clarity varied from company
to company, our analysis of disclosed firm takeaway and hedges from E&Ps points to
ECA, CXO, RSPP, and EGN being least exposed to any further expansion in midland
differentials (with OXY stating they would see a net benefit), while XEC and PE are
most exposed.

Capital discipline and shareholder focus should continue to be a priority across
the energy industry. E&P companies largely stuck to the theme of prioritizing
returns and staying disciplined to their capital budgets, noting that the downturn
forced meaningful improvements in capital efficiency, which all are keen to
maintain. While E&Ps have been the most vocal on this, services and refiners are
attempting to assuage investor concerns around excess capacity growth. See
more here.

MS Top Pick is Continental Resources (CLR)

If you would like to get the full report (24 pages), send an email to me at dmsteffens@comcast.net