Energy’s Slow Road Back to “Boom”

Matthew Carr By Matthew Carr, Emerging Trends Strategist, The Oxford Club

Oil & Gas

The price of crude has doubled from its lows in February 2016. Still, it’s down 54.5% since the global collapse began in June 2014.

But, as I’ll explain, there are signs that the energy market as a whole is on a slow road back to “boom.”

A Rough Five Years for Energy Investors

Despite oil’s surge the past 14 months, the sector continues to trail the broader market by a wide margin.

Over the past five years, the Energy Select Sector SPDR ETF (NYSE: XLE) has been negative. At the same time, the Dow Jones Industrial is up more than 60%, as you can see from this chart…

Even year to date, the fund is down 10%, while the Dow is up more than 6%.

Over both the long term and the short term, it’s been a nightmare for energy investors.

But don’t worry… brighter days are ahead.

Back to Black

During the two years of crude’s price collapse, oil and gas companies slashed their capital expenditure (capex) budgets by 40%.

On the front lines, 400,000 workers lost their jobs. And with oil prices below $50 per barrel, projects totaling $620 billion were deemed no longer profitable and were either deferred or canceled outright.

But late last year, we started to see a bright spot. And it’s getting brighter…

In the fourth quarter of 2016, capex by 44 onshore-based oil producers increased by $4.9 billion – a 72% increase from the fourth quarter of 2015. That’s the largest year-over-year increase for any quarter from these companies since at least as far back as the first quarter of 2012.

This is a simple trend to follow: Higher crude prices boost earnings for U.S. upstream companies. That in turn encourages them to step up their investments, which leads to increased production and increased revenue.

The third quarter of 2016 was when the U.S. earnings recession ended. We know this because it was the first time since the fourth quarter of 2014 that energy companies posted positive earnings.

After almost two straight years of falling earnings, capex suddenly surged in the fourth quarter of 2016…

And capex spending by oil companies didn’t slow in the first quarter of this year either.

At the end of March, the number of oil rigs operating in the U.S. jumped 26% compared with the same time last year.

Plus, global capex spending is expected to increase 9% this year. And this was recently increased from the original 7% forecast in January.

A lot of this surge is coming from North America, where upstream capex is expected to increase 32% in 2017… and in one area specifically.

Most of the money is heading to the Permian Basin, where roughly $16 billion has been spent since the start of 2017. This includes the massive 250,000-acre acquisition by Exxon Mobil (NYSE: XOM) that holds an estimated 3.4 billion barrels of oil equivalent.

That doubles Exxon’s resource base in the Permian.

As I’ve written here before, everyone’s rushing to the Permian because it offers attractive breakeven prices.

To give you an idea of how big an uptick we’re seeing, consider this…

In 2016, oil and gas companies spent $28 billion on acreage in the Permian Basin – that’s three times what was spent in 2015.

And real estate in the Permian is going for as much as $60,000 per acre – several times the price of other shale areas.

A lot of the activity is focused on the Midland Basin in the Permian.

Just as a refresher: The Midland is the largest continuous oil field ever discovered in the U.S. It’s estimated to contain 20 billion barrels of oil, as well as 16 trillion cubic feet of natural gas and 1.6 billion barrels of natural gas liquids.

That makes it three times larger than North Dakota’s Bakken Formation and worth $900 billion.

Early 2017… A Sign of What’s to Come?

In just the first three months of 2017, U.S. producers have spent 57% of what was spent in the Permian in all of last year.

And that means big production and revenue increases are on the horizon.

We’re really starting to see a turnaround for energy companies. In the first quarter of this year, the S&P 500 is projected to report 9.2% year-over-year growth. This is the most since the fourth quarter of 2011. It will also mark the first time the S&P has reported three consecutive quarters of growth since the third quarter of 2014 to the first quarter of 2015.

And that’s all thanks to the energy sector.

The sector is expected to report earnings of $7.5 billion. That’s a $9 billion increase over the first quarter of 2016, when the industry reported a loss. And if the energy sector were removed, earnings growth for the S&P would be just 5.5%.

It’s a slow road back to “boom.” But we should start seeing the pace pick up speed. The energy sector is driving earnings for the S&P. And energy shares should follow.

Good investing,