Market Musings 110224: Oil As A Contrarian Theme

11th Feb by Edmund Shing

20 comments 1835 reads

Market Musings 110224: Oil as a contrarian theme

Robust oil demand could outweigh growth in oil supply

Summary:

Look outside of Tech for unloved contrarian ideas
Oil & Gas did very well in 2022, but little in 2023
Several reasons to expect better fundamental momentum from oil and gas prices
Focus on key subsectors with momentum: US refinersUS energy infrastructure

Podcast this week:

The Magnificent Seven meet the Good, the Bad, ad the Ugly

Edmund Shing, Global Chief Investment Officer at BNP Paribas Wealth Management explains the evolution of the Magnificent Seven, and guides to what the future may hold for them. Who are the Good, the Bad and the Ugly? $197 billion and the link with Meta Is Apple tumbling from the heights? Do Tesla’s dashboard warning signs reflect its current woes, Why the Magnificent Seven are splintering?

Looking for ignored sectors outside of Tech: Oi & Gas

Since the beginning of 2022, the Oil & Gas sector has been one of the best performers in the US, and also in Europe. In addition to the 50% for the US oil majors since January 2022 and the +22% for European oil & gas majors, we can add healthy dividend yields of 3.5% per year in the US and 4.8% in Europe. Admittedly, this performance came mostly in 2022, and oil & gas companies have done relatively little over 2023 and into 2024.

The key reason for this lack of performance over the last 12 months is clear: the Brent crude oil price has not made any progress in 2023-24. Today Brent crude oil sits at $82 per barrel, around the same price as at the beginning of 2023.

Natural gas prices have fared even worse over 2023-24: US natural gas prices have declined to their lowest level since 2020 at under $2 per thermal unit, while European gas prices (represented by the Dutch TTF benchmark) have also declined to the lowest levels since mid-2021 at EUR27/MWh.

Potential catalysts for Oil & Gas stocks

After the lacklustre performance of oil & gas stocks over the last 12+ months, why am I once again interested in this out-of-favour sector?

I see a number of potential catalysts that could be positive drivers for oil & gas earnings in the coming months.

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G Morris

14th Feb

Shell has just released report saying LNG demand will increase by 50% to 2040 and America is now the largest exporter. Have previously looked at the pipeline companies with their high yearly dividends but put off buying any individually with many of them incorporated as partnerships and possibilty of any future tax complications residing in the UK, so thank you for the suggestion of EFT Invesco Morningstar US energy infrastructure UCITS.

KevinS1

15th Feb

Thanks Edmund. Only just caught up on this article and some very useful suggestions around some ETF's which I will look into further.

My own O&G choices have not performed well in the last 18mths and I am now left with just one holding Serica Energy (LON:SQZ) which is looking pretty sick at the moment, but I hold on in hope of it regaining its previous highs. It pays a nice dividend whilst I wait, but its cash holdings have dropped off recently and it keeps talking about expanding further, so I worry its divi might get cut.

Carey Blunt

I agree that the sector may well do well but for me it’s not something I feel I can continue to invest in from an ethical standpoint. Each to their own and I wouldn’t want to evangelise some ethical viewpoint but personally….i’m happy to leave the Oil and Gas opportunities on the table and look elsewhere. I would be interested on views on which O and G player is diversifying the most successfully though.

Alphaflight

These days its just taken as axiomatic that the modern world doesn't need oil, gas or coal anymore. Those of us that live in the real world understand that oil isn't going away. Modern farming for example is merely a function of oil. Diesel machines, fertilizer, pesticides and so on are all based on oil/gas. No more oil/gas would mean no more modern farming - most of us would consequentially starve.

Anyway, it is interesting to note that fertilizer, the corner stone of modern farming, is directly correlated to natural gas prices. So if you buy fertilizer companies such as Mosaic Co (NYQ:MOS) , Nutrien (TSE:NTR) you are effectively capturing moves in the natural gas price.

Speaking of natural gas, Australia’s largest oil and gas producer Woodside Energy (LON:WDS) is still yielding >10% p.a. Woodside accounts for about 5% of global LNG production

16th Feb

A 10% dividend on a share that’s down 20% in a year doesn’t seem like it would have been a good bet though. Maybe it’s a better bet now but it’s still got a forecast revenue drop of nearly 10% in the next year.

While not relevant for the very near term, no more oil and gas doesn’t at all mean the end of modern farming….in fact what you describe as modern farming is really old fashioned farming. Actual modern farming in something like 7 years time will be food grown using precision fermentation techniques. I expect that a massive chunk of the Dairy, Palm Oil and many other things to be grown rather than farmed. Smart private money is going into companies like Savor and C16 bioscience, the Every company, Formo etc. In that 7 year horizon it will be possible to produce milk cheaper than dairy farming, the same for lots of other goods.
Sadly I can’t find a way to easily invest in future food trends.

I think when you say “those of us who live in the real world” you mean “those of us who are stuck in the current world” maybe? As an investing thesis for the long term, I much prefer future trends for a world with much much less hydrocarbons than a world where it prospers.

"A 10% dividend on a share that’s down 20% in a year doesn’t seem like it would have been a good bet though. Maybe it’s a better bet now but it’s still got a forecast revenue drop of nearly 10% in the next year."

So perhaps don’t invest in equities if you can’t handle some volatility?

“While not relevant for the very near term, no more oil and gas doesn’t at all mean the end of modern farming….in fact what you describe as modern farming is really old fashioned farming.”

Carey I’m not a farmer but I do own two farms. I live on one of my farms and frequently use a quad bike (powered by nasty petroleum) to haul stuff around. I also run sheep on this farm with a 'proper farmer' friend of mine. Again try transporting sheep around without diesel. I recently had to dismantle fencing, it would have been very expensive to do this with manual physical labour - what would take one man a few weeks can be done much cheaper in a single afternoon with a (diesel powered) tractor.

"Smart private money is going into companies like Savor and C16 bioscience, the Every company, Formo etc. "

Nope. Smart money buys real economy farm land. Smart money also buys cheap high quality companies such as Wilmar International (SGX:F34) , Asia’s largest agricultural company et al. Dumb money on the other hand is following this WEF net zero nonsense narrative investing in unicorn farts...

“In that 7 year horizon it will be possible to produce milk cheaper than dairy farming, the same for lots of other goods”

This is delusional. It sounds like you are aligned to the notion that we no longer need farmers.

"Sadly I can’t find a way to easily invest in future food trends."

There are many ETFs aimed at future food trends. For example Global X Agtech and Food Innvtn UCITS ETF USD Acc (LON:KROP) . For ethical reasons I wouldn't invest in this :-)

NeilS

18th Feb

The easy way, though speculative is Agronomics (LON:ANIC) which is providing capital to the future of food. Many of their investments intend to do as you say -even perfect leather for luxury fashion houses from lab grown leather without an animal croaking in the process.

23rd Feb

Of course I don’t think we will no longer need farming….but I do think that farming can and will be disrupted just like other industries. The cost curve for precision fermentation is pretty clear. When it’s cheaper to produce milk products without the cows then the dairy industry is going to have to change. The dairy alternative milk market (already worth big money) is also going to be in trouble. I really recommend you research this, it’s absolutely not delusional.

You realise that you can get battery powered ATVs and battery powered JCBs and zero emissions tractors right? None of your use cases for diesel actually require diesel in the future. If electricity is cheaper than diesel for the use case then farmers will be switching…absolutely no doubt. You can already find cases of farmers switching to save money. Farmers also understand our relationship with the land better than most and see the sense in equipment that lowers pollution while being cheaper and more technically sophisticated to increase yields.

We could have been having this conversation 10 years ago about electric cars with you telling me it would never happen and me telling you the cost curves don’t lie. In 10 years we will all be scoffing at how your perception of it all being unicorn farts got in the way of you investing without bias.

There is money still to be made in oil of course, short term, I just think imagining that usage will not change and drop in all its use cases is delusional.

Lincs

25th Feb

Carey much as I applaude the sentiment in your posts I would take issue with your statement (and obvious cherry picking) view of

'You realise that you can get battery powered ATVs and battery powered JCBs and zero emissions tractors right? None of your use cases for diesel actually require diesel in the future.'

Of course there are battery powered alternatives to virtually everything these days but it doesn't mean they are viable options or that they are zero emissions. We all know that there are far more emissions created in the manufacture of an EV in comparison to an ICE so straight away they are not zero emission. Where is the source of the electricity used for re-charging coming from? In the UK largely from gas turbines - fossil fuel. In the future more will be from renewables and nuclear but that neccesitates more nuclear.

Now to the practicalities. Your idealogy only works with an assumption that every farm job is undertaken for a short period of time and that the battery can be topped up by a source that is convenient and close to hand. That just isn't the case. Around 80% of agriculture is on an industrial scale here in the UK (and elsewhere) where large co.s own and run great swathes of land. They own and use enormous machinery for economies of scale - those economies now mean that an increasing number of smaller farmers now contract in the services and machinery of the larger farmers to perform the required tasks around their own farms, The smaller farmer simply cannot afford those larger machines and it's a cost saving to use the contracting services of others. To pay their way and to be profitable those larger machines are run hard throughout the year and for many hours in a day - sometimes 24hrs a day during harvest times. They complete the task on one farm and move straight on to the next. I remember seeing a promotional for a battery JCB mini digger - great little thing. It ran fume free, silently and matched the power of its deisel equivalents - for 2.5hrs. Then it needed to be hooked up to a deisel generator for 8 hours to re-charge. Working remotely some distance from an electricity supply it was impractical to repeatedly ferry the JCB back to the farm to re-charge it after every 2.5 hrs of work. How would your electric powered goliath tractors fair in this environment? The power they use is enormous - they simply will not be able to match even an 8 hour workload (let alone a 24hr workload) without an enormous supply of swop-able batteries packs. How many battery packs would need to be swopped every few hours. An average tractor making a 5 - 6 furrow plough uses around 10 ltrs of deisel per hour. In hard clay like ground that could rise to 15ltrs per hour depending on tractor and conditions. A rough guide is that there is 10kwh of power per litre of deisel. So every 2.5-3 hrs (or less) one would need to swop the equivalent battery packs of 4 Tesla Model Ys. Simply not feasible, either from a cost perspective, an environmental perspective or on a practical basis.

Now if you'd used hydrogen as an alternative to deisel instead of the usual EV alternative it would go someway to mitigating all of the impracticalites of your EV arguement. But it still wouldn't be as practical as deisel. If you are operating an enormous machine (or more likely several enormous machines) far from your source of fuel it's relatively easy to tow a single small deisel bowser to supply that fuel - the calorific value of deisel is immense. How many swoppable battery packs would one require in the EV option? Of course you wouldn't want to take a deisel generator as that would a) destroy the EV arguement and b) be pretty slow at charging the batteries anyway. A hydrogen tanker could be used if hydrogen was the fuel of choice but would be far larger, more complex and costly than using a simple bowser.

DWit199

It's worth noting that BMW and MG recently had rulings against them by the Advertising Standards Authority for advertisements containing a zero emissions claim as it is misleading. Ford got away with it, just, by using the phrase "Zero emissions driving".

To add to some of Lincs excellent points...

Dr Gail Tverberg talks extensively about this subject, I remember one of her articles discussing battery powered agricultural machinery. Amongst other things, she points out that as they are very heavy, they compact the soil and adversely affect it (less drainage and so on). If you are interested then see her work here.

"In 10 years we will all be scoffing at how your perception of it all being unicorn farts got in the way of you investing without bias."

I have a significant amount of capital allocated towards oil tankers, offshore oil and gas, and coal sectors so I sincerely hope you are wrong:-)

The problem with Hydrogen is that we need to expend energy in order to make it (i.e. we can't dig a hole in the ground and find it). With abundant cheap nuclear generated electricity however, hydrogen would be an elegant solution perhaps.

BnB

The problem with Hydrogen is that we need to expend energy in order to make it (i.e. we can't dig a hole in the ground and find it).

And that is where you are very wrong. Geologists are finding natural hydrogen gas reserves all over the world. Those with a vested interest are proclaiming a new “oil rush”. I expect they are exaggerating but let’s hope they are at least half right.

XTR

Alpha, you might want to read this, I can't vouch for the veracity of the article but significant if it's recoverable.

I too read Gail Tverberg from time to time but I can never work out her stance on anthropogenic GW

26th Feb

Hi XRT / BnB,

Thanks.

Yes I'm sure there are a better energy sources than oil/gas/coal but humans haven't found them yet in terms of EROI (see below) other than nuclear. For example Helium-3 is a rare isotope on Earth, but it is abundant on the Moon, this would solve some problems if we could access it cheaply (which we clearly cannot due to EROI). Thorium reactors look interesting and so on .

Unfortunately right now we can't move away from oil without civilizations collapsing...probably G7 civilizations collapsing because BRICS control 80% of crude and 90% of natural gas production. Moreover non-G7 countries couldn't give a hoot about net zero.

Mankind found billions of years’ worth of the sun’s energy trapped in a black liquid. We've burnt through most of said liquid now. I’m afraid peak oil is a very real problem (see the Hubberd curve et al). So this is indeed the end of the oil age I suspect. We certainly need alternatives but so far we have nothing, All we have are "fossil fuel extenders" (wind, solar, etc). The materials used to make these rebuildables require fossil fuels. For example a lot of the rare earth metals come from China because, the Chinese like coal, and the byproducts of coal are some of these key rare earth metals...without them neodymium (i.e. strong magnets used in wind turbines) are harder to come by. As for Chinese made solar panels, they are made using coal (see here). Then you've got concrete required for those windmills, you need lots of that and guess what you need to make concrete. I could talk about copper too, look at the amount of energy required to extract copper (Dr Chris Martenson talks about this extensively).

Speaking of coal, look at China, they are selling the west solar panels but what are they doing in their own country? They are building lots of coal power plants. China insists that these new coal fired power plants are being constructed to operate as backup to wind and solar:-)

It is important to understand that humans have never gone from a higher density energy source to a lower energy density source in the last 40,000 years – see Oil engineer Art Berman and others talking about this. Link

“… but I can never work out her stance on anthropogenic GW”

I believe that Dr Gail Tverberg talks about carbon dioxide representing 0.04% of the atmosphere. Humans produce 3% of that 0.04%. so that's about 0.03*0.04=0.0012%. In other words our contribution to carbon in the atmosphere is negligible.

As our entire civilization is based on oil, without it we can’t support these population levels. The economy is merely a surplus energy equation. Countries without access to cheap energy sources will not grow (because growth requires surplus energy). For example here is one of Dr Chris Martenson's simple charts illustrating population growth Vs oil. In other words human population growth is merely a function of surplus energy (derived from oil). Why would this be? Mainly because our food requires oil/gas (pesticides, herbicides, diesel machinery, fertilizer) in order to be produced. Think of bacteria on a petri dish, they will keep growing and consume all of the available energy (food), after that their population will collapse. i.e. the famous school boy experiment.

The problem with other energy alternatives is EROI (Energy Return On energy Invested).

Source

To tap into the hydrogen you mention for example, we would have to expend a lot of energy, probably via diesel fuel mainly, in order to remove the rocks and transport them. It would cost less energy to make hydrogen from electricity derived from nuclear power Vs using diesel this way.

To put things into perspective, back in the original days of those US Nodding Donkeys (image below), the US was burning one barrel of oil to pump out 100 barrels of oil. So the EROI was high, around 100. Today we are seeing very low figures from tar sands etc, <3.

So mankind has gone from EROI's of 100 all the way down to below 3 in a relatively short period of time.

aflash

Alphaflight asked about BPT (New York) last June and I managed to steer him away.

Type in the symbol and look at 'Discussions' to find the same table at that time.

To applaud an interesting article and comments I re-visited the same group of U.S. based MLPs.

The index (pink line in the middle) has gone sideways and only a few stocks have beaten the trend.

So how do we evaluate them now?

Discounts: Many have narrowed, so either the properties have been re-valued upwards or investors are paying more, despite the drop in price.

Yields: Minefield, some take one's breath away but may not be maintained. I shall only buy a stock that is paying out shortly and probably sell after it goes ex-dividend.

Then I looked at the charts and fundamentals and have made a short list of stocks moving in the right direction, still good value and paying out.

DYOR

Hi aflash,

Too much Middle Eastern exposure could be a bad idea right now but I think that a sharp move in oil prices would send a lot of these oil royalty companies through the roof. Note: look up Charlie Munger's oil Royalty story, his best investment of all time I believe in terms of returns.

Charlie Munger pocketed $70,000 a year from a $1,000 investment he made in 1962 - and likely raked in over $1 million in total

Tankers:

The tankers interest me a lot for various reasons. For one thing few people have been interested in them and I'm a contrarian investor. Interest seems to be gathering pace but they are all still cheap.

The main tanker companies (DHT, FRO,TNP, etc) are definitely worth owning for a whole host of reasons. However if this red sea closure to G7 countries continues then the day rates will stay high or keep rising. In terms of (expected) dividends, DHT pays >8%p.a., FRO pays over 12% p.a. (however the withholding tax is of course omnipresent with these!).

If you chart DHT, FRO and TNP on top of each other you get the same pattern (see image below), the sector bottomed out for a long period and is now gaining momentum and moving up. Note that if these companies return to their previous all time highs (seems likely to me at some point) in the future then you are looking at >10X returns.

The key thing here is that these older ships are being scrapped and new ships are not being built to replace them (so higher day rates either way eventually). This seems like an easy investment thesis for the patient investor. Meanwhile you get paid for waiting...

Yes, indeed,

The ships were missing from Edmund's article.

VLCC (Very Large Crude Carriers):

and the LNG (Liquified Nat Gas) ships:

However, when I came to look at the charts only LNG (Cheniere Energy) seemed interesting, with a short-term set-back in an established uptrend.

Bought and Sold twice in 2023 and now waiting for purchase price to be met.

SHEL is one one the largest LNG players, more than oil apparently.

At a premium according to above data base but I hold.

27th Feb

Yes true that regarding the tankers missing. Also the entire offshore oil and gas sector is missing, this sector has the highest convexity in my opinion hence my biggest positions lie there. I sold a lot of my uranium exposure a few weeks ago and added to my offshore oil and gas exposure.

By the way, there is now an ETF that tracks Global Offshore Oil Services Range Global Offshore Oil Services Index ETF (PCQ:OFOS) . I've been buying some of these companies for a few years now so I don't own the ETF (also the ETF fees are quite high).

DHT Holdings (NYQ:DHT) for example focuses specifically on crude oil tankers, it is a pure play. All of the ships they own (23 of them) are VLCCs (the largest type of crude oil tanker). The supply backdrop (i.e. few new ships being added to their fleet or others) could lead to a very tight market situation.

Yes Shells is still a big player in the LNG market.

This article today didn't surprise me. Reminds me of the precious metals market.

This time last year I was selling put options via IBKR on some of these big oil companies. Glad I stopped doing that as by now I would have got the direction wrong, forgetting that the physical reality isn't reflected in the paper prices.

Oil Spreads Soar As Physical Market Screams Tightness While Hedge Fund Press Shorts

"...Yet despite this continued decline in supply and inventories, oil prices remain rangebound and seem unable to breakout solidly about the low 80s. Why is that? In a word: financialization, aka "paper oil", because while the physical oil market is screaming higher, financial players (managed money) continue to aggressively sell and short the sector as shown in the chart below."

28th Feb

That suggestion was acted on immediately. It has only been listed a short time, 2 holdings on markets I have no access to. Thank-you.

Alphaflight's farms are wired up.

Anecdotally, agriculture evolves

The only trader of grain futures on the Chicago exchange ever met works from his trucking company garage in isolated northern Quebec.

I have just sold a vineyard in Argentina for a thumping loss, despite the climate being ideal. Land values are governed by irrigation rights in the area. Investors in a vineyard in rainy Oregon made fortunes. Vines have been cross-cultivated and now produce in low sunlight, cold areas.

The purchaser of my vineyard specializes in onion seeds, will tear up the Syrah and plant tomatoes too. For those look to the Israelis who put boxes one above the other for high production in limited space. My dentist invited them to his native Bulgaria for a similar project. Try following Israeli innovation in irrigation, a by-product of climate change and over-population is water shortage, despite rising ocean levels.

Then there are the chemical processes which Israelis excel at. ICL to Delek, mainly US based now.

It needs an article from Edmund Shing on Agriculture, otherwise comments will get lost.

After taking some profits when inflation expectations were higher I am moving some money back into the sector.

There are sub-sectors within the sector.

Machinery, just taken a position in AGCO.

Fertilizer, some potash producer trades last year.

Soft commodities, bringing me losses at the moment.

Trading houses, such as ADM (Archer-Daniels-Midland) whose problems dodged by selling in Jan 2024 so have just taken a new position.

WYN (Wynstay) I hold.

Land companies such as CRESY and the Timber etf WOOD.

Conglomerates, all well known.

Haha I like it! Their Range Global Coal Index ETF (PCQ:COAL) ETF is also interesting. Again I own some of these individual coal stocks so I don't really have any need to use the ETF. Also I'm not sure what sort of yield the coal ETF is expected to generate. My average yield on my portfolio of coal stocks is still >20%p.a. I believe i.e. very high.

Sorry to hear about the vineyard losses! I still have high hopes for Milei's Argentina, time will tell. I own a farm next door in Brazil, we grow sugar cane, we have some cattle, fruit etc but the main business is a eucalyptus tree plantation. Consequently every 5 to 7 years the farm looks like a bomb site as the trees are felled...

Archer-Daniels-Midland Co (NYQ:ADM) is a company that interests me a lot (their competitor also: Bunge Global SA (NYQ:BG)). Archer Daniels own 20% of Wilmar International (SGX:F34) which I have a large allocation.

Yes I too own a small amount of Wynnstay (LON:WYN)

I did own some Cresud SACIF y A (NSQ:CRESY) , I still hold a few Argentinian companies, my largest holding are YPF SA (NYQ:YPF) and Banco Macro SA (NYQ:BMA) .

Fertilizer

I've got a lot of exposure to fertilizer but with the low natural gas prices and so on they aren't doing so well - this doesn't concern me, they will rebound at some point.

Also I can see natural gas prices rising for lots of reasons...this article from today is worth reading.

Note that I bought Altius Minerals (TSE:ALS) a few years ago, they have done well in terms of growth (not cheap now though). Altius has a massive potash royalty exposure as well as other things that interest me. They are a treasure trove of commodities if you look into their royalties see here. If we get another commodities bull market , Altius should do well. I still hold Rusagro and Phosagro on the Russian MOEX but it is all frozen, I did hold the phosagro ADR and that seems to have been vaporized like my other western listed Russia stocks/ETFs/Investment Trusts.

Market Musings 110224: Oil as a contrarian theme