How I'm Playing the Energy Sector Amid Harvey's Hit

 | Aug 28, 2017 | 5:06 PM EDT
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I had that sinking feeling today watching the price of crude oil. Harvey's impact on the Gulf of Mexico refineries clearly pressured oil prices, with WTI and Brent both plunging in Monday's trading. The logic seems to be that as refineries are down, U.S. crude will bottleneck like the Brazos River is doing just now. That said, if Hurricane Harvey hadn't been so impactful, I can see the stories headlined "With Harvey gone US oil producers will continue over-producing" or the like. Sadly, that was not the case, but the point is that negative sentiment -- whether on the underlying commodity or the companies that produce it -- can be very difficult to overcome.

It is difficult to gauge Harvey's impact since the storm itself has merely paused, not dissipated. Many of the companies that will dictate the pace of the recovery were not operating today because Houston's downtown and Energy Corridor areas are still not possible to reach via highway.

I saw earlier that ConocoPhillips (COP) and Baker Hughes (BHI) both closed their Houston corporate offices today, and the widely attended DUG Eagle Ford conference scheduled to be held this week in San Antonio has been postponed. There's going to be some paralysis this week among energy companies, and, obviously, the health and safety of their employees is paramount. Best wishes to all my friends and colleagues in the Houston area.

At some point, though, the stocks get so cheap that one just has to fight sentiment. As I mentioned in my Real Money column Friday, the fundamentals for oil ex-Harvey have turned bullish, in my view, and I just can't believe the carnage in the E&P stocks in August.

A good example is PDC Energy (PDCE) , a Colorado-based player that made a $1.5 billion acquisition in the Delaware play (in West Texas far from the storm-hit areas; closer to New Mexico than the Gulf of Mexico) in December 2016. On Aug. 8, PDCE reported a 54% year-on-year increase in production for the second quarter, and its shares fell 31% in the second quarter.

Since the end of the second quarter, PDCE shares have fallen another 12%, and it is almost as if the amount of hydrocarbons the company produces doesn't matter. It most assuredly does. It is difficult to justify a share price for PDCE that values the company nearly 50% lower than a year ago when it is producing 50% more oil than it did then.

So, the bargains are out there, and Harvey's impact is adding further fuel to the bear runs currently hitting independent E&P stocks such as Sanchez Energy (SN) , Carrizo Oil & Gas (CRZO) , Noble Energy (NBL) and Chesapeake Energy (CHK) . It's very difficult to find the bottom in an unloved stock group, but one way to play the disconnect between rising production and falling valuations is to go higher on the capital structure.

Chesapeake common shares hit a 52-week low today, and I believe this selloff is as overdone as CHK's epic plummet to $1.60 in February 2016. No, Chesapeake didn't declare bankruptcy and yes it's still a solvent company.

That said, I find it difficult to risk my clients' capital on such a volatile stock (even though my spreadsheets tell me I should) so I chose a third way. I have been buying Chesapeake's Preferred Series D (CHK-D) today and Friday. These shares trade at 51 cents on the dollar to yield 8.8%, and the last day to buy to receive the announced September dividend is tomorrow.

So, I'm hanging out in CHK-D until I get the courage -- or see any nascent shift in sentiment -- that will allow me to take the plunge on CHK common or any of its independent E&P peers.

Getting more than the S&P 500's currently indicated annual yield in one quarterly payment is enough compensation for the risk inherent in the energy markets, and the stock market will eventually realize the undervaluation of CHK-D.

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