Energy Prospectus

It was a tough week for the overall market. Despite WTI and HH natural gas prices ($84.79/bbl and $3.95/MMBtu) staying well above what I am using in all of my forecast/valuation models, the Sweet 16 declined 14.25% during the week. As of Friday's closing prices, the Sweet 16 is now up 4.52% YTD. Not bad for three weeks into the year, but still a painful one week adjustment.

The S&P 500 Index declined 5.56% and is now down 7.73%. Fear that the Fed will be forced to take drastic measures to slow inflation has many investors moving money out of the market. If you are in that camp, there are some great places to park some money in our High Yield Income Portfolio. All four of the minerals companies (BSM, MNRL, FLMN and VNOM) pay variable dividends that should be increasing this year. Falcon Minerals (FLMN) is now a "special situation", so read the profile we sent out on Friday before you invest in that one.

I have updated all of the individual company forecast/valuation models, breaking out 2022 by quarter and adding my initial forecast for 2023. For both years I am basing my forecasts on the assumptions that WTI will average $80/bbl and HH natural gas will average $3.50/MMBtu). I expect all 16 companies to report strong Q4 2021 results since WTI averaged $76.84/bbl (compared to $67.60 in Q3) and HH natural gas averaged $5.83/MMBtu (compared to $4.01 in Q3).

Forward guidance from each company will impact my valuations, but I believe that my production forecasts for 2022 and 2023 are conservative.

Four of the five "gassers" (AR, CRK, EQT and RRC) are now down YTD and in my opinion are now oversold. CTRA is the only gasser that stayed in the green. As I mentioned in Friday's webinar, the weather forecast for the last two weeks of January is bullish for natural gas, so I see nothing to justify last week's selloff of this group other than overall market weakness. They are all in MUCH BETTER shape than they were a year ago.

Leading the pack are EOG (up 13.2% YTD), ESTE (up 10.88% YTD), PDCE (up 10.72% YTD) and MTDR (up 9.13% YTD). Their revenues are heavily weighted to oil. EOG is one of the few large-caps that is telling the market they remain committed to 10% annual production growth. Per my forecast, EOG should generate approximately $10.5 billion ($17.86/share) of operating cash flow this year and over $5 billion of free cash flow. EOG is the largest company in the Sweet 16 with a market-cap over $58.8 billion. Diamondback Energy (FANG) is a distant second with a market-cap of $21.4 billion.

Based on Friday's closing prices, the Sweet 16 trades at a forward PE ratio of just 5.57 and forward operating cash flow multiple of just 2.85. Companies of this quality should trade for 6X to 8X operating cash flow per share.

My task this week is to update all of the forecast models for the companies in our Small-Cap Growth Portfolio. I talked to Don Simmons, CEO of Hemisphere Energy (HMENF) on Thursday. He recently sent out an encouraging operations update and he will be hosting a live webinar for us soon. My updated forecast models for Hemisphere and Talos Energy (TALO) have already been posted to the EPG website. You can find them under the Small-Cap tab.

Fundamentals remain strong.

Trading Economics:
"WTI crude futures retreated to around $85 per barrel on Friday after hitting a fresh 7-year high of $87.1 in the previous session, as an increase in crude and fuel stockpiles prompted investors to take profits from the rally. According to official data from EIA, crude inventories in the US rose by 515,000 barrels last week, rising for the first time since November and defying market expectations for a 938,000 barrel drop. Gasoline stocks also increased to an 11-month high of 246.6 million barrels, while refinery runs declined slightly and pointed to lower demand for crude. Oil markets were also dragged by a global selloff in equities as investors reduced exposure to risk assets on prospects of higher interest rates. Meanwhile, oil prices have gained more than 10% so far this year as strong demand and supply constraints significantly tightened the market."

"US natural gas futures jumped towards $4 per million British thermal units after hitting an over two-week low of $3.78 on January 20th, underpinned by expectations of record demand and tight supplies. Weather forecasts showed colder temperatures for the fortnight ahead, which is expected to cause domestic inventories to stand below the 5-year average for the first time since mid-December, as utilities draw larger-than-normal amounts of gas from storage. Meanwhile, a cold snap in Texas and other producing states has frozen wells and other equipment, curtailing output levels to their lowest in four months. Production in the lower 48 states averaged 95.3 bcfd so far this month, down from a record 97.6 bcfd in December."

>the Sweet 16 declined 14.25% during the week.

Oh, the humanity!

Q4 results and strong year-end reserve reports should get the Sweet 16 back on track.

Oil and gas prices will get support from the "supercycle".

In recent weeks, high-priced tech stocks have been selling off, while stocks in the commodities space have done relatively well. Commodity stocks were some of the best performers in 2021, after underperforming for much of the past decade.

The bounceback in demand from the pandemic has been strong, while the new U.S. infrastructure bill and global demand should only increase the need for more metals and energy. That's why Goldman Sachs analyst Jan Hatzius recently predicted last year's gains mark the beginning of a 10-year "supercycle" in commodities, and not just a one-off surge.