Energy E&Ps Sit Between Heaven and Hell

 | Apr 06, 2017 | 3:00 PM EDT
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I attended the IPAA's Oil and Gas Investment Symposium (OGIS) this week in New York. Independent exploration and production (E&P) companies are always at the cutting edge of the boom-and-bust world of fossil fuel exploitation, but this OGIS had a different feel than previous ones I had attended.

In contrast to the OGIS circa 2014, there was no air of exuberance in the air this week at the Sheraton Midtown, but the vibe was also remarkably more bullish than the funereal atmosphere that pervaded 2016's NYC OGIS.

So, that's where the independent E&Ps stand, metaphorically speaking: somewhere between heaven and hell. In terms of the stocks, these are not Goldilocks names, however. Historically, the time to buy has been when things looked bleakest (February 2016, for instance) and the time to sell has been when the conference is standing-room-only and executives are all wearing Texas-sized grins (summer of 2014, for instance.)

So, with WTI front-month crude futures sitting at $51.73 a barrel and Henry Hub natural gas front-month futures at $3.30 per mm BTU as of this writing, there is no knee-jerk "you gotta buy" or "you gotta sell" reaction. It's not that easy. To buy (or short) an E&P stock with commodity prices at current levels, one must do intense, deep-dive research on individual names.

Therein lies the problem for E&P stock longs -- but also the potential opportunity. Energy stocks, broadly speaking, were a huge laggard in the first quarter of 2017, with the Energy Select Sector SPDR ETF (XLE) down 7.5% vs. a 5.8% gain for the S&P 500 and a 10% gain for the Nasdaq Composite.

Looking at the performance of E&Ps, specifically, shows an even larger relative underperformance. The (XOP) Exploration and Production Select SPDR fell 9.6% in the first quarter.

This has to be viewed as a buying opportunity for independent E&Ps -- and, as a contrarian, I'm glad that OGIS wasn't jam-packed with salivating investors. I'd rather buy the names a little bit early, and then benefit when the herd stampedes into the trade.

I think the biggest problem for smaller independent energy stocks isn't the daily data points on OPEC members' complaints with November's production cuts (that incredibly fractious cartel has been remarkably united on the production cuts this far, in my opinion) or the weekly data that show seemingly ever-increasing U.S. onshore oil rig counts.

No, I believe the biggest hindrance for independent E&P stocks has been portfolio managers' rotation into other sectors. But I love that. And the fact the I didn't have to use my surgical elbowing skills (honed through 25 years of riding the NYC subway) to navigate through OGIS is a bullish indicator for the independent E&Ps in my role as an active money manager.

If you've been reading my Real Money columns for the past three years, you'll have gathered that I have a lot of friends among the management teams of smaller energy companies. It's fun to reconnect, but honestly, I can afford to buy my own glasses of bourbon. What I really want from these guys is a signal that things are robust in the field, so that I can input that into models and generate an economic case to rotate into the sector.

My clients and I are still very heavily involved in shipping, especially dry-bulk, but as we look to harvest those gains -- such as in my RM Best Idea, Navios Maritime Preferred Series G (NM) , which have more than quadrupled since I recommended them last January -- I am looking squarely in the direction of the independent E&Ps. I believe the sector as a whole is massively undervalued.

So, I'm bullish from a macro perspective, and in tomorrow's column I'll update you on developments at three of my favorite individual stocks in the sector, Evolution Petroleum (EPM) , Torchlight Energy (TRCH) and Gastar Exploration (GST) . I had the opportunity to meet with senior management at all three companies at OGIS, and I believe each of these three smaller names has outsized upside potential for patient investors.

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