Hello, I am Tortoise Managing Director and Portfolio Manager Rob Thummel with this week’s Tortoise QuickTake podcast.
Last week, we released our Halftime Analysis of the U.S. Energy Sector. The highlights of the report are as follows. First, the energy infrastructure sector and utilities are leading the charge in terms of performance across the energy sector. Energy infrastructure extended its lead last week rising by approximately 1% and is now up over 22% year-to-date. In general, yield-oriented equities are performing well given the sharp decline in the 10-year Treasury yield. Oilfield services stocks are the laggards in 2019 as the sector remains challenged by declining revenues and eroding margins.
Second, OPEC has set the stage for stable oil prices for the remainder of 2019 and the recent rise in natural gas prices provides a positive commodity backdrop for the second half of 2019. Third, short-term fundamentals point toward higher U.S. energy production that positions the U.S. as a net energy exporter by the end of the year. Lastly, the energy sector is in the beginning stages of building a mountain of free cash flow over the next several years. We believe this will become more evident in the second half of the year and investors will reap the rewards tied to a basic fundamental premise that has driven the stock market higher for years - that is rising cash flow.
Three topics to highlight this week.
First, we believe that increased U.S. LNG exports to China will be one of the headlines when a final trade deal with China is reached. Why? China needs to reduce carbon emissions and the best way to do that is to reduce its coal consumption that currently represents 58% of China’s energy supply. China has set a goal to increase its natural gas mix that currently represents 7% of energy supply to 10% of Chinese energy mix by 2020 and 15% by 2030. What does mean in terms of new natural gas supply?
Over the next 12 years, China potentially needs to source 60.2 billion cubic feet per day of natural gas. For perspective, today U.S. natural gas shale fields produce a little over 65 billion cubic feet per day. The magnitude is so large because China’s population is over four times the size of the U.S. yet China’s natural gas consumption today is less than one-half that of the U.S. So, where will China get its natural gas from?
Domestic production within China from conventional sources will grow slightly. A common question we get is what is the potential for shale gas in China? Shale gas production is focused on the Sichuan Basin located in southwest China. This basin is 89 thousand square miles compared to the Marcellus Basin in the U.S. that is 104 thousand square miles. The early returns on shale gas drilling have not been good, and as a result, international major energy companies like BP (NYSE:BP), Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B), Exxon (NYSE:XOM) and ConocoPhillips (NYSE:COP) have quit exploring for shale gas in China due to high costs and low returns.
This is why we think U.S. exports of LNG to China will be a significant component of the trade deal. We don’t believe that China will be able to meet its natural gas demand with domestic sources alone. We forecast Chinese LNG demand will be 4x current levels by 2030. China is preparing for more LNG imports as the Ministry of Transport plans to quadruple import capacity in the next two decades from 19 terminals receiving 8 billion cubic feet per day to 34 terminals receiving up to 30 bcf per day.
The second topic to discuss is an extension of the first as it relates to U.S energy exports. Last week, Enterprise Products Partners (NYSE:EPD) announced additional expansion projects at the Houston Ship Channel. These projects increase Enterprise’s capacity to export liquefied petroleum gas, propylene and crude oil. In fact, Enterprise forecasts that by 2025, exports of U.S. crude oil will increase from three million barrels per day today to eight million barrels per day.
The last topic relates to the results of the intense proxy battle between the Rice team and existing management over the board and management of EQT Corporation (NYSE:EQT). Shareholders overwhelmingly elected the Rice team-nominated directors. The Board then appointed Toby Rice as President and Chief Executive Officer of EQT Corporation replacing Rob McNally. Rice has initiated its 100-day plan with a goal of increasing free cash flow by $500 million equating to a free cash flow yield of 19%. At Tortoise, we continue to support acceleration of free cash flow for all stocks in the energy sector.
Disclosure: I am/we are long BPMP, EPD, EQT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The S&P 500® Index is a market-value weighted index of equity securities.
The PCE inflation rate is the Personal Consumption Expenditures Price Index. It measures price changes for household goods and services. Increases in the PCEPI warn of inflation while decreases indicate deflation.
Broad Energy = The S&P Energy Select Sector® Index is a capitalization-weighted index of S&P 500® Index companies in the energy sector involved in the development or production of energy products.
Producers = Tortoise North American Oil & Gas Producers IndexSM
The Tortoise North American Oil & Gas Producers IndexSM is a float-adjusted, capitalization weighted index of North American energy companies primarily engaged in the production of crude oil, condensate, natural gas or natural gas liquids (NGLs). The index includes exploration and production companies structured as corporations, limited liability companies and master limited partnerships but excludes United States royalty trusts.
MLPs = The Tortoise MLP Index® is a float-adjusted, capitalization weighted index of energy master limited partnerships (MLPs). The index is comprised of publicly traded companies organized in the form of limited partnerships or limited liability companies engaged in transportation, production, processing and/or storage of energy commodities.
The indices are the exclusive property of Tortoise Index Solutions, LLC, which has contracted with S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC) (“S&P Dow Jones Indices”) to calculate and maintain the Tortoise MLP Index®, Tortoise North American Pipeline IndexSM and Tortoise North American Oil and Gas Producers IndexSM (each an “Index”). S&P® is a registered trademark of Standard & Poor’s Financial Services LLC (“SPFS”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and, these trademarks have been licensed to S&P Dow Jones Indices. “Calculated by S&P Dow Jones Indices” and its related stylized mark(s) have been licensed for use by Tortoise Index Solutions, LLC and its affiliates. Neither S&P Dow Jones Indices, SPFS, Dow Jones nor any of their affiliates sponsor and promote the Index and none shall be liable for any errors or omissions in calculating the Index.
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