Oil & Gas Sector Investing

[vinod1]

The oil and gas sector seems to be beaten to a pulp. I keep track of sectors just to see how they are doing. The case of S&P Oil & Gas Equipment & Services ETF (XES) which uses equal weighting is particularly striking.

It has fallen more than 86% from its high. Its returns look like what stocks have experienced in the great depression. It fell -35%, then was again cut down -35%, then cut down -50%, and then cut down again -25%.

The energy sector weighting in the S&P 500 hit a new low of 4.5% now, compared to previous low of 6% in 2000 and a weight of 28% in 1980.

This seems closer to what banking was in 2011. If you fear mean reversion in S&P 500 earnings and PE, it would be your friend in this case.

I have never been much of an Oil & Gas investor, other than dabbling once in SD LEAPS and a 2 week dalliance with Penn West. But with many of the businesses I follow closer to a sell and finding myself with increasing cash, I am seriously considering taking a diversified position in the energy sector. The main assumption is that the sector would exhibit some mean reversion.

Looking to invest in this sector via two equal weight ETF's (XOP and XES) to get diversified exposure to this sector.

Question to the energy experts who invest in individual energy stocks, do you have any recommendations on what segments of the energy market might be more undervalued or any specific ETF recommendations.

Thanks

Vinod

[forest81]

Interesting. I see the expense ratio is 0.35% for XES. However I assume they chop and change stocks all the time so there must be a loss in there for all the trading. Do you have an idea what this expense is?

[SharperDingaan]

Assuming you are purely passive and your holding period is 3-5 years, just select based on lowest monthly cost.
You are betting on the tide coming in, and could care less if you are in a cruiser or a row-boat.

Everyone is sure they know different but with commodity companies, you are primarily betting on the macro, not the micro.
Is the forward demand/supply for the commodity your bet produces, improving? If yes, where do I get the most bang for the buck; if no, why am I  still holding this.

SD

[CorpRaider]

The oil and gas sector seems to be beaten to a pulp. I keep track of sectors just to see how they are doing. The case of S&P Oil & Gas Equipment & Services ETF (XES) which uses equal weighting is particularly striking.

It has fallen more than 86% from its high. Its returns look like what stocks have experienced in the great depression. It fell -35%, then was again cut down -35%, then cut down -50%, and then cut down again -25%.

The energy sector weighting in the S&P 500 hit a new low of 4.5% now, compared to previous low of 6% in 2000 and a weight of 28% in 1980.

This seems closer to what banking was in 2011. If you fear mean reversion in S&P 500 earnings and PE, it would be your friend in this case.

I have never been much of an Oil & Gas investor, other than dabbling once in SD LEAPS and a 2 week dalliance with Penn West. But with many of the businesses I follow closer to a sell and finding myself with increasing cash, I am seriously considering taking a diversified position in the energy sector. The main assumption is that the sector would exhibit some mean reversion.

Looking to invest in this sector via two equal weight ETF's (XOP and XES) to get diversified exposure to this sector.

Question to the energy experts who invest in individual energy stocks, do you have any recommendations on what segments of the energy market might be more undervalued or any specific ETF recommendations.

Thanks

Vinod

I'd be interested to get your take on some of the midstream names like WMB and KMI.

[Cigarbutt]

I've been looking at this since 2015 and have pulled the trigger a few times. One of the trigger was Penn West, for a few months in 2016, and a regularly updated long-term price picture showing the stock price evolution (and name change) has been one of the reasons holding me back.
But maybe Vinod is right at this point?

The odds for a reversal of fortune appear to be high but it's hard (at least for me) to come up with a reasonable framework. I thought a WTI price range of 40 to 60 would be a potential input for entry and exit points but now, if I eventually bring this idea to fruition, I wonder if a basket approach would have a better risk-return profile. The basket would contain two majors: Royal Dutch Shell ADR and Exxon, an integrated Canadian: Suncor and two natural gas candidates: Tourmaline and Arc Resources.

Why:
From a fundamental point of view, supply factors continue to look favorable and I think the transition will take longer than presently discounted. Also, looking at some charts, on a relative basis, O+G stocks are way down in the neglected and despised bin. Take a look at the following graphs (pages 53, 54 and 55 of document). Note: I think the title of the document should be: In independent Thought We Trust and I don't intend on buying gold this time around.
https://acting-man.com/blog/media/2019/10/Chartbook%20of%20the%20IGWTreport%202019.pdf

Why not:
Looking at the above charts and spotting the last two times when relative valuations looked favorable, first, during the nifty-fifty era, the gap was closed when markets came back to reality, a process which happened during an oil crisis and second, during the dot-com episode, the gap was closed when markets came back to reality, a process which happened during the massive rise in energy demand from China (think PetroChina investment). This time around, there does not seem be a supply-driven context on top of the general supply-related variables and the jury is still out on the market reality component.

At this point, in my book, the why not wins but this is an interesting area to follow.

[vinod1]

forest81 - I do not have any idea right of the top of my head. But have looked at implementation costs from research by AQR and by Rob Arnott on factor strategies. To me the returns from the asset class either positive or negative is going to swamp out the costs over my investment time frame of 3-5 years.

CorpRaider - I am a novice in O&G, so do not have a view on midstream or any of the players Hence my passive (index) approach to the sector.

Vinod

[vinod1]

Cigarbutt - Very good points and cannot disagree much with what you say.

The way I am looking at this is:

The median stock in the sector fell as much as the market did during the great depression. Note the sequence of returns  over the last 6 years (2014 to 2019 YTD) -34.72%  -36.57%  +28.42%  -21.93%  -46.99%  -23.76%

No reason it cannot go down another 50% and then another 50%. But that should be the probable bottom as the sector would represent 1% of the overall stock market cap. The sector is not going to disapear or get disrupted out of existence.

So a martingale type approach would work reasonable well in this near worst case scenario (a further 75% drop from this level). Say total limit of 10% of portfolio to this strategy. We start with 3%, if it drops 50% put another 3%, when it drops another 50% put 4%. If it drops further, I would start reading the fannie and freddie thread...

More likely some mean reversion seems probable and the investment should provide decent returns.

This is not really my preferred way to invest, but I am running out of ideas where I can recycle the money from the investments I sold out of recently.

Vinod

[Gregmal]

Having done the above in 2015 and early 2016 I would point out some things that occurred

I created a basket of about 20 names, similar to the breakdown Cigarbutt described in regards to sector specifics.

Dividend reinvestment saves you big time. BP and RDS particularly, I had pretty average entry points, but over time the dividends did make a difference

You'll need to give yourself(from a risk management perspective) at least 4 shots at entry points before acquiring a full position(similar to the post above)

Some will be zero's, most will perform within the same general range. You will likely have one or two major outperformers. I was lucky to get TPL at $114 for instance. Made up for stuff like Halcon

The approach and your subsequent return will be much more reliant on your execution and discipline rather than your ability to pick specific companies. Make sure to trim on the way back up with a slightly less, but generally consistent frequency with which you were accumulating, at least until you recoup a reasonable chunk of your original investment. I was fortunate to largely exit the basket in mid 2018. I gave back a lot of the previous year rebound; overall the returns were probably worthwhile, but nothing spectacular. The key is to avoid becoming a victim of a bear market rally. Be vigilant as well with anything that is borderline investment grade.

[Spekulatius]

I used to be relatively heavily invested in  O&G, but completely bailed in 2014 when prices really started to fall. I re- entered the sector in late 2015, but concentrated entirely on midstream and pipeline companies (and their bonds back then), because I figured that bottlenecks would be transportation rather than production. In addition, the midstream have pretty nice dividends which over time really make a bit difference. I am also now invested mostly in midstream, I own some KMI (acquired lower prices) and WMB ( a bit in the red). In really like WMB because it is 2/3 utility and only q/3 gathering and it yields 7% with a good chance of dividend increases.

I have sell  and buy these opportunistically. For. New entry, I like WMB, best in class EPD (if it falls below $25) and perhaps PAGP.

I think international majors like RDS and BP, as well as the better operators like SU and CNQ are investible on an opportunistic basis too.

Another interesting group to look at are Met coal producers. These are not energy stocks per say, as met coal is an input for steel reduction rather than electricity for thermal coal. The sector is pretty washed out and a stock like ARCH (which has some thermal coal exposure too) looks very cheap, despite low cost production and a strong balance sheet. I don’t own it yet, but I think I might buy into this at some point.

[Viking]

Great discussion. I have also been getting a little interested in commodity producers: energy and miners. Both are hated sectors. I did recently buy a small piece of TECK. I find owning (even small a small amount) gets me more motivated and focussed. If i buy more it will likely be an ETF.