Energy Prospectus

An updated Sweet 16 spreadsheet that shows my valuation for each company compared to First Call's price forecast will be available on the EPG website later today.

It was a rough week for all of the upstream companies. The Sweet 16 dropped 6.7% and is now down 24.4% YTD. Somewhat interesting is that the First Call price targets have barely moved since Q3 results came out. Today's oil price is unsustainable and most analysts know it.

SM Energy (SM): I have updated my forecast model and my valuation. My Fair Value Estimate has been lowered to $58.60/share, compared to Stifel's valuation of $48.00/share and First Call's price target of $42.83/share.

SM has been hammered because many analysts consider it a "gasser". To some extent that is true. The company's Q3 production mix was 45% natural gas, 28% NGLs and 27% crude oil. However, thanks to their good hedging program, 55% of their revenues came from oil sales. 45% of SM's Q4 production is hedged at very good prices and more than 40% of their 2016 production is also hedged at good prices.

My valuations of the Sweet 16 are based on a multiple of operating cash flows per share. My new valuation for SM is 5X CFPS, which is a low multiple for a company of this size that has a strong balance sheet, a strong hedge position and lots of running room.
First Call's Cash Flow Forecasts for SM:
2015 = $14.09
2016 = $11.75
2017 = $13.68
2018 = $18.25

SM recently updated the presentation on their website. I urge you all to take a look at it. This is a rock solid company that deserves a much higher share price.

Devon Energy (DVN): I need to spend more time on Devon because the HUGE acquisition that the company announced last week will have a big impact on future production and their product mix. Since we are deep in a Bear Market, the Wall Street gang's initial reaction to almost any news is negative. Yes, Devon is going to issue more stock to close the deal, but they will have the top position in STACK which is a World Class oil play. First Call's price target is $55.90/share and I rate DVN a Strong Buy at today's share price.

I believe 2016 is shaping up to be a repeat of 2010:
> The midpoint of 2010 was the end of the last 2 year oil price cycle. The price cycle we are in now started in July, 2014.
> Year-end tax loss selling is pushing down share prices. If oil prices just stabilize, we should see a bit of rebound after Christmas.
> In 2010 the Sweet 16 got off to a great start, moving up about 20% in the first quarter. I expect to see lots of money "rotate" into the energy sector in Q1 just because many fund managers will rebalance their portfolios. Keep in mind that energy is just like food, critical to human survival. Oil & gas prices cannot stay lower than finding & development costs for long.
> In 2010 the Sweet 16 finished up 54% with about half of the gain coming in Q4.
> Global demand for oil is somewhat seasonal, with demand ramping up annually during the second half of each year. See chart at: https://www.iea.org/oilmarketreport/omrpublic/
> Non-OPEC oil production is falling and demand continues to increase. IEA forecasts 1.2 million bbls per day increase in demand for refined products in 2016. I believe that IEA's forecast is too low. When the final numbers are in, 2015 demand will have increased by 1.8 to 2.0 million bbls per day. I expect similar numbers in 2016 since low fuel prices always cause demand to go up. In 2010 the YOY increase in oil demand was 3.3 million bbls per day.

Thanks to a warm December, demand for North American natural gas has been below normal so far. The good news is that the El Nino is now weakening and we should see much colder temperatures for the eastern half of the U.S. by early January. Watch Joe Bastardi's weekend weather update at: http://www.weatherbell.com/

Things are shaping up for some record draws from natural gas storage in February. LNG exports will be ramping up and we now have more natural gas fired power plants that stay up all year thanks to many coal fired plants being shut down.

Another reason I am bullish for upstream energy companies in 2016 is because Super El Ninos change to Super La Ninas the next year. La Nina winters are much colder and the North American natural gas market is going to be much tighter a year from now.

Barron's: Oil Stocks: Will the End of Tax-Loss Selling Provide a Boost?
By Ben Levisohn

Nomura’s Lloyd Byrne and team consider the impact of the end of 2015–and with it the end of tax-loss selling–on oil stocks like Pioneer Natural Resources (PXD), Newfield Exploration (NFX), Suncor Energy (SU), EOG Resources (EOG), Canadian Natural Resource (CNQ) and Encana (ECA):

Bloomberg News

We agree with many that January appears set up for a relief rally as tax loss selling and year-end portfolio positioning pressures abate. But investors will seek incremental visibility into longer-term supply and demand fundamentals before buying with any conviction, in our view. Our view remains the same, viewing the oil cycle as a “U.” The depth of it is in question, though, as futures have fallen below our current $50/bbl WTI forecast for 2016. But the goal remains: survive 2016 and keep some production leverage to the cycle when it eventually returns. Within our Large Cap coverage, top picks include Pioneer Natural Resources, Newfield Exploration, Suncor Energy, EOG Resources, Canadian Natural Resource and Encana.

Might look at EOG again after reading Art Bermans report.

http://www.artberman.com/blog/

I agree with Art that the Permian Basin (and 99% of the U.S.) is uneconomic at $30/bbl, but to say EOG is "lying" about the potential they have in the Permian Basin is going a bit too far. Large-caps like EOG think a bit more long-term than most of us.

I have followed EOG for many years. It is a world class company that holds the best leasehold position in the Eagle Ford and is top five in several others.

EOG is on-track to generate close to $4.0 Billion in cash flow from operations in 2015. This compares to their capital expenditure budget of ~$4.8 Billion. They have a VERY STRONG balance sheet, so they can handle a bit of an over-spend. BTW they generated $8.2 Billion in cash flow from operations in 2014.

Here is the deal:
> The U.S. is one of the world's largest producers of oil and it is the world's biggest consumer.
> This world MUST have Non-OPEC production growth and the U.S., Russia and Brazil are the only non-OPEC members that were increasing production even when oil was $100/bbl. All three countries will be on decline in 2016.
> Non-OPEC production is on decline and the rate of decline is going to accelerate in 2016.
> OPEC countries are "bleeding money" at today's oil price. 2/3s of OPEC members are flat broke and "rich countries" are watching their bank accounts fall.
> This is a very capital intensive business and "Capital" will not fund sub-economic projects.

So, what happens when production falls and demand goes up?

There will be some upstream companies that don't make it, but EOG isn't one of them.