Sweet 16 Update - October 31

[dan_s]

It was a mixed week for the Sweet 16. As a group it was up 0.3% on the week and is now down 5.5% year-to-date, compared to the S&P 500 Index that is up 1.0% YTD. These are all solid companies with strong operating cash flows.

RRC, SM and SWN all reported 3rd quarter results last week that were in-line or slightly better than my forecasts.

RRC and SWN are the two big "gassers" in the portfolio. 3rd quarter should be the low point for the year for the gassers as the outlook for natural gas prices should improve over the next 60 days. In the 4th quarter it is all about the weather for the natural gas producers. Super El Nino winters start slow, but Dr. Joe Bastardi is forecasting a colder than normal winter for the South, which is bullish for gas demand. It will be interesting to see how the market reacts when Cheniere (LNG) ramps up exports.

RRC and SWN both have a lot of Marcellus and Utica production. There are several large midstream projects coming on-line within the next 60-90 days which will significantly improve gas prices in the region this winter. Listen to RRC's 3rd quarter conference call and look at the recent presentation on their website.

There is not a lot being said about it, but U.S. natural gas production is now on decline and demand for gas will be 3 BCF per day higher in 2016.

The other 13 companies in the Sweet 16 all report Q3 results next week. I will be driving to Dallas on Monday afternoon for our luncheon on Tuesday and we have the luncheon in Houston on Wednesday. Therefore, it will be Thursday before I can focus on updating forecasts. I am cracking the whip on the interns, so we will update all of the Sweet 16 profiles by mid-November. Keep an eye on your e-mails as we will be sending out a lot of reports in the weeks ahead.

I was very encouraged by the operational update from SM Energy. Their production will be down a bit in Q4 because they are pushing off most completions until 2016. Next year should be a great year for this company if oil just gets back to $60. Even at today's oil & gas prices, SM generates about $200 million cash flow from operations each quarter. They have a strong balance sheet and it is easy for them to live within cash flow and generate steady proven reserve growth. Our updated profile and forecast for SM is now on the EPG website.

As you should all be able to figure out from the HUGE drop in the active rig count, today's low oil, gas and NGL prices are unsustainable. IEA is now estimating that demand for refined products has increased by 1.8 million barrels per day in 2015. That is the largest increase in five years. Think about it. The global economy is sluggish at best and demand for refined products is soaring. Take a hard look at this graph: https://www.iea.org/oilmarketreport/omrpublic/ Note that Q4 is the period of the highest demand.

Price does make a difference. When fuel is cheaper and available, demand goes up. When the final numbers are in, my bet is that actual demand has increased by more than 2.0 million barrels per day. Remember, all people want a higher standard of living and energy is what provides it.

Over the last five years (2010-2014) the United States generated 83% of global oil production growth. Today our oil production is declining by more than 100,000 per day each month and the rate of decline is accelerating.

The seeds of the next Oil Crisis are sprouting. Within six to nine months global demand for oil will exceed supply.

When we update each company's profile we will take a HARD LOOK at cash flow from operations, their hedges and their liquidity. The companies that make it through the cycle with their balance sheets in decent shape and a large inventory of low-risk drilling locations will soar when oil & gas prices rebound. At the end of the 2008-2010 oil price cycle, the solid small-caps had 500% to 1,000% increases in share prices.