Hello. I am Tortoise Managing Director and Portfolio Manager Rob Thummel with this week's Tortoise QuickTake podcast.
Another week and another change in the direction of a U.S. and China tariff negotiations. Last week, the U.S. and China agreed to resume trade talks in early October. This news, combined with Federal Reserve Chairman Powell's comments related to keeping the U.S. economic expansion going, lifted stocks last week with the S&P 500 rising by almost 2%. The energy sector as represented by the S&P 500 Energy Select Sector Index followed suit rising by almost 3%.
The fall conference season kicked off last week with the annual Barclays CEO Energy-Power Conference. All of the energy industry heavyweights attended, and so did we. Let me give you some of the highlights of what we heard and how many of conference themes align with initiatives already in motion at Tortoise. Exxon Mobil (XOM) is the largest energy company in the world, and its CEO Darren Wood delivered a message to a packed house outlining the future of the energy sector. Mr. Wood rarely speaks on quarterly conference calls, so like the E.F. Hutton slogan from the 1970s goes, when Darren Wood talks, people listen. What we heard were some similar themes that have been discussed in several of our podcasts. Exxon's CEO believes energy is essential. But Mr. Wood said we are in the midst of an energy transition, yet energy transitions take a long time. He pointed out that it took oil 100 years to eclipse coal as the primary fuel mix. In the meantime, the world's rising demand for energy must be met. Looking forward, Mr. Wood pointed out that energy consumption rises as standard of living improves. According to Wood, this is a significant opportunity for the energy sector as 50% of the global population lives in countries with low to medium standards of living based on the U.N. Human Development Index. As the standard of living in these countries improves, so will global energy consumption. However, Exxon also recognizes the challenges associated with higher energy consumption. That challenge is carbon emissions. Exxon is committed to addressing the carbon emissions challenge. To address emissions, low carbon solutions need to be adopted by China and India now. In addition, wind and solar need a large scale battery solution for the world to maintain the energy reliability standards that we have become so accustomed to. It was national news when the lights went out in New York City for five hours earlier this summer. According to Exxon, lithium is not the solution to energy storage. Therefore, research and development needs to be accelerated to find a better solution.
The timing of Exxon's comments coincides with a soon-to-be-released white paper from us here at Tortoise entitled The Teal Energy Deal. In this paper, we address what we think are the fastest and least expensive ways to reduce global carbon emissions as the global demand for energy increases. Here is a sneak peek at the core themes of the soon-to-be-released white paper. Global energy demand will continue to rise driven by electrification. We believe that the world can reduce carbon emissions even in periods of rising demand by eliminating coal and replacing it with low carbon fuels like natural gas as well as renewables. The U.S. plays an important role as part of the solution by exporting low carbon, low cost energy to the rest of world. We go into much more depth about each of these topics in the paper that will be released on our website very soon. Our CEO Kevin Birzer is very passionate about this topic. Videos of Kevin's perspectives will be on the website as well. In addition, we have a large team of over 50 investment professionals committed to the Teal Energy Deal, and we are looking for investment opportunities every day as the energy transition unfolds.
Back to other highlights from the Barclays conference. Google says the two most popular celebrities right now are Kylie Jenner and Kim Kardashian. I say the two most popular energy companies at the conference were Antero Resources (AR) and Range Resources (RRC). My assessment was based on the size of the crowd attending the presentations put on by these companies. I'm pretty sure that the number of people in the meeting room exceeded allowed capacity. Going into the conference, Range and Antero were two of the most heavily shorted stocks in the energy sector, with short interest representing 33% and 19% of the respective float of each company, given near-term weak natural gas prices and current debt levels of both companies. Both Marcellus producers articulated compelling arguments for rising global demand for natural gas and the role that the Marcellus will play in filling a significant portion of that demand. The crowd must have liked what it heard as Range and Antero were two of the best performing stocks in the energy sector last week rising by 10% and 11%, respectively.
A new theme that permeated this year's conference from oil and gas producers was a drive toward higher dividends from generation of free cash flow. The producers have been talking about generation of cash flow in excess of capital expenditures or free cash flow for a while, but now that this is becoming a reality, we are getting more insight on how the excess cash will be allocated. Most of the oil and gas producers that presented want to increase dividends until their dividend yield is in line with the S&P 500. After that, buying back stocks seems to be the most popular choice.
While the producers are going in the right direction, in my opinion, the presenters at this conference missed out on an opportunity. The current yield for the 10-year Treasury is around 1.5%. Investors around the world are starving for yield. According to Bloomberg, the dividend yield of the energy sector is currently 3% that is 1.5x the yield of the S&P 500 while EV/EBITDA multiple of the energy sector is half that of the S&P 500. It's important that these producers raise dividends in line with energy sector peers to attract new investors to the space. Of course, energy infrastructure dividend yields are already quite compelling with most energy infrastructure stocks yielding 6% or higher. If the economy falters a little, investors want to own stocks that pay cash dividends. If the economic expansion continues and your return expectations for equities are 8% to 10%, it seems reasonable to buy energy stocks that could deliver half of your expected return from dividends. Buying energy infrastructure stocks could possibly get you 75% to 100% of your expected return from cash dividends. I think you get the point.
The last notable comment from the Barclays Conference came from the sage of the energy industry Mark Papa. Mr. Papa is the former CEO of EOG Resources (EOG) and is now the CEO of Centennial Resource Development Corporation (CDEV). Papa stated that estimates for 2020 U.S. oil production growth are too high. In fact, he believes that U.S. oil production growth will slow to 700,000 barrels per day, which is 40% lower than the 1.2 million barrels per day expectations. We agree with Papa, and a decline in the rig count for the third consecutive week is making that prediction look even more likely. Our view is that lower U.S. oil production growth is a positive for the U.S. energy sector as it will stabilize energy prices.
Disclosure: I am/we are long AR, RRC, EOG, CDEV. 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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