Sweet 16 Update - June 27

[dan_s]

The Sweet 16 pulled back about 3% last week even though there is no change in the outlook for oil or gas prices and almost no news at the individual company level. My guess is that the stocks trade sideways until we see 2nd quarter results that come out the end of July and early August. By then we should have a lot more evidence that U.S. oil production is on decline.

Since mid-April, West Texas Intermediate (WTI) has been trading in a tight range of $58-$62. WTI closed Friday at $59.70.

The Sweet 16 is up 9.4% YTD, compared to the S&P 500 Index that is up just 2.1%. The "Greek Tragedy" seems to be a dark cloud over the market these days. Oil traders are looking for clues on how a Greek default will impact oil demand in Europe. My SWAG is "not much".

I do check my valuations against First Call's Price Targets each week. For most of the S-16 the price targets continue to drift slowly upward. The group is now trading at better than a 50% discount to my valuations.

I do not recall ever seeing such big spreads in the analysts' EPS forecasts submitted to First Call. It is clear that there is quite a bit of disagreement on what oil and gas prices should be used in their forecast models. Analysts are required to use their firm's "official" oil & gas price decks in all of their forecast models.
Here are some examples of the spreads in Earnings per Share forecasts for 2015:
Company Name / EPS Low & High
Concho Resources (CXO) / $0.63 to $2.16
EOG Resources (EOG) / $-0.64 to $1.26
Newfield Exploration (NFX) / $0.20 to $1.73
SM Energy (SM) / $-2.66 to $1.38

Considering the fact that we are almost half way through the year, it is hard to justify such wide spreads in the earnings per share forecast models. The spreads for 2016 EPS are much wider with the low forecasts only possible if one assumes $40 oil and $2.00 natural gas prices.

My opinion is that oil prices will drift higher as it becomes clear that U.S. production is on decline.
Last week I took a hard look at Plains All American Pipeline (PAA), which is one of the midstream MLPs in our High Yield Income Portfolio. PAA is one of the largest midstream MLPs and it is heavily weighted to the oil side with gathering, processing and storage facilities all over North American. They have a small army of analysts that track drilling, completion and production activities all over the country. On their website you can find a presentation that supports their believe that U.S. oil production has peaked and will decline by over 500,000 barrels per day by year-end. My opinion is that U.S. oil production will be declining by more than 100,000 barrels per day each month starting in July and the rate of decline will accelerate. If the number of rigs drilling for oil stays this low, there is no way to keep U.S. oil production from falling.

One slide in the PAA presentation shows what would happen if the U.S. just stopped all drilling activity. Their estimate is that U.S. production would decline by 2,200,000 barrels per day within twelve months after a total shut down, primarily because of the steep decline rates in all of the tight oil plays. Obviously, we cannot stop drilling in the United States and the economics are still very good in the Tier One acreage of the major oil plays even if oil averages $50/bbl.

Concho Resources (CXO) pulled back more than $10/share last week. This is a "Core Holding" quality company and my Top Pick in the Permian Basin. If you do not own CXO, now would be a good time to build a position in it.

Bonanza Creek (BCEI) and SM Energy (SM) are trading at the deepest discounts to my valuations. BCEI looks like a Screaming Takeover Target to me. It is a pure play on the Niobrara/Codell play in Northern Colorado. It is the smallest company in the Sweet 16.

I do think we will see several mergers announced in the next 3-4 months.

Natural gas is "off the radar screen" in the summer, but I think we are setting the stage for a much tighter North American gas market for this coming winter. Texas gas production is on steep decline. LNG exports start in Q4. The Sweet 16 with a lot of exposure to natural gas are RRC, GPOR, XEC, DVN, EOG, NFX and SM. If the price of natural gas moves over $3.50/mcf, these companies will draw a lot more attention from Wall Street. Higher gas prices will also be great news for all of our upstream MLPs.

This week we will publish updated profiles on AXAS, EMES and JONE. I intend to "crack the whip" on a few of our interns that owe me some profile updates this week.

[bearcatbob]

Dan, FWIW - here in NE Ohio there is no summer. It currently is all of 72 F and rain is everywhere. The 10 day temp forecast is for much more coolness. So much for NG this summer.
Bob

[dan_s]

Most of the gas fired power plants for back up power (to run our air conditioners non-stop) are in the South. Although we've had a cool spring, summer has arrived and so has the humidity.

See the slides I spoke from in Dallas on Thursday and you will understand why I am very bullish on natural gas prices this winter. Gas production in Texas is falling like a rock.

See:Texas oil and gas production has taken a 'huge hit'

http://www.businessinsider.com/texas-oi ... own-2015-6