Analysis: Sizzling rally in US energy stocks has room to run, bulls say

Texas Pacific Land (Dover)

21/09/2023 17:05

By David Randall
       NEW YORK, Sept 21 (Reuters) - Contrarian investors were
rewarded for betting on the beaten down U.S. energy sector
earlier this year with a blazing rally. Some believe a tight oil
market and resilient U.S. growth will keep energy stocks rising
for the rest of 2023.
    The largest U.S. energy exchange traded fund, the Energy
Select Sector SPDR Fund  XLE.P , is up nearly 15% over the last
three months and stands near its highest level in nine years.
    The move follows a rally in oil that has taken the price
ofU.S. West Texas Intermediate crude (WTI)  CLc1  up more than
30% since June on supply concerns from extended production cuts
by Saudi Arabia and Russia, as well as unexpected strength in
the U.S. economy.
        Bullish investors argue that energy stocks are still
cheap by historical standards - and far less richly valued than
other areas of the market. The energy sector currently trades at
a forward price to earnings ratio of 12.2, well below its
historical median forward P/E of 15.3, according to LSEG
Datastream. The S&P 500 trades at a forward P/E of 20.
    "Valuations can go up even if the oil price stays static
because on a cash flow basis these stocks are very reasonably
priced," said Charles Lemonides, head of hedge fund ValueWorks
LLC, who is overweight the sector.     
    Energy stocks surged last year as inflation jumped to
40-year highs but landed with a thud at the start of 2023, when
expectations of a U.S. recession and oversupply encouraged
investors to take profits. 
    Both forecasts failed to materialize: economic growth in the
U.S. proved far more resilient than many had predicted, despite
the Federal Reserve’s most aggressive monetary policy tightening
in decades. 
    Meanwhile, drillers have been taking rigs offline,
contributing to what is widely seen as a tight market, while
Russia and Saudi Arabia have curtailed production. 
        The U.S. rig count is about 16% below where it was this
time last year, according to data from U.S. energy services firm
Baker Hughes. Overall, U.S. oil output from top shale-producing
regions is on track to fall for a third month in a row in
October to the lowest level since May, the U.S. Energy
Information Administration said.
    Despite recent gains, the S&P 500 energy sector is up only
4.2% year-to-date, compared with a 38% rise in technology stocks
and a nearly 45% rise in communication. The broader S&P 500
index is up about 16%. 
    "Energy companies have newfound supply discipline" that will
keep oil supply constrained, wrote Savita Subramanian, equity
and quant strategist at BofA Global Investors, who has an
overweight on the sector. 
    Citi on Monday became one the latest banks to predict that
global benchmark Brent crude  LCOc1  could exceed $100 a barrel
this year. 
    While higher oil prices tend to eventually weigh on demand,
that is unlikely to happen until Brent rises to between $110 and
$120, said Bjarne Schieldrop, chief commodity analyst at SEB
Research. 
    At the same time, continued production caps by Russia and
Saudi Arabia will keep a floor under oil prices for the time
being, he said.
    Parts of the market appear skeptical energy stocks have much
further to run. 
    Bearish investors point to the sector’s earnings, where
growth rates are expected to decline by 37% in the third
quarter, followed by double-digit declines in both the fourth
quarter and the first quarter of 2024, according to LSEG
estimates. 
    Energy demand could suffer if a rebound in the economy of
top commodity consumer China fails to materialize. A 2024
recession in the U.S. - which many strategists still view as a
possibility despite growing hopes of a soft landing, could also
weigh on oil prices. 
    Persistently high oil prices could also lead to worries over
a rebound in U.S. inflation, bolstering the case for the Fed to
cool economic growth by keeping rates higher for longer.
    “A supply driven increase in oil prices brings the prospect
of both a renewal in inflation … and a slowdown in real consumer
expenditures,” analysts at Macquarie wrote.
    Still, Rodney Clayton, a portfolio manager at Duff & Phelps
Investment Management, believes the energy sector's large
dividends will attract income-seeking investors - especially if
the economy falters and bond yields fall.
    "Companies are building up the trust of investors and are
very reluctant to cut those dividends," he said. "That should
result in a ... smoother ride for energy stocks than we’ve been
accustomed to."

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 (Reporting by David Randall; Editing by Ira Iosebashvili and
Marguerita Choy)
 ((David.Randall@thomsonreuters.com; 646-223-6607; Reuters
Messaging: david.randall.thomsonreuters.com@reuters.net))