Frackers Can Reap the Oil Rally - If They Ignore It
(Bloomberg Opinion) -- We are a couple of weeks away from earnings season kicking off in the oil patch. Might this be when fracking stocks catch up to oil prices? It will depend largely on how hard fracking companies try to catch up to oil prices.
Oil prices have risen more than half since their late-2018 slide bottomed out on Christmas Eve. Exploration and production stocks have risen by just 26 percent over the same period and effectively gone nowhere since mid-January, while oil continued rising.
The disconnect is mirrored in earnings forecasts. Consensus estimates for the E&P sector kept falling into early 2019 even after oil prices had begun to recover. Lagging the rolling one-year forward earnings consensus by a month shows it tracking forward oil prices closely during last year’s rally and subsequent crash – until Christmas:
In a recent email to clients, analysts at Tudor, Pickering, Holt & Co. noted that consensus forecasts for oil prices in 2019 were in the range of $50 to $62 per barrel. The current futures strip is just above that level. Given bullish short-term factors such as the escalating conflict in Libya, Saudi Arabia’s supply cuts and the potential wildcard of Iranian sanction waivers, price decks in earnings models could be due for an upgrade. And earnings season may provide the catalyst.
There’s a catch, though.
Intentional or not, analysts’ caution mirrors that of investors. The latter assign oil-price rallies a lifespan of months rather than years at this point, given the potential for everything from presidential tweets to frackers’ natural urges to push the other way. Don’t forget demand either: On Tuesday, the International Monetary Fund cut its forecast for global economic growth to the lowest in a decade.
Moreover, E&P stocks have fallen out of favor due to a history of excessive spending leading to poor returns and neutralizing the option value related to oil-price swings. Activists have targeted several companies, particularly smaller frackers with bloated unit costs, demanding governance reforms and a focus on higher returns and cash payouts. On Tuesday, Kimmeridge Energy Management Co. filed a proxy statement nominating directors for its target, PDC Energy Inc. Meanwhile, Laredo Petroleum Inc. announced late Monday it was replacing its CFO and taking steps to cut its overhead by about 25 percent.
So earnings season will require some delicate balancing. If higher oil prices start lifting expectations on profit and cash flow, the big question will be where the extra money goes: new wells, paying off debt or into shareholders’ pockets? Last year, when oil prices rallied similarly, wells won out, teeing up the production surge that helped sink prices, and E&P stocks, toward the end of 2018. In a sense, the best way for E&P companies to reap some recognition of those higher oil prices would be to ignore them.
To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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