by Robert Rapier, Investing Daily
Article of the Week from Investing Daily
Around the end of each year, I reflect on the year in energy and make projections about the year ahead. These articles review the year’s top energy stories. I also grade the energy predictions I made the previous January.
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But I like to lead off this series with some projections about where I think the energy sector is headed in the year ahead. I will use these projections to finalize my annual energy predictions in early January.
Today I will discuss the outlook for the oil and gas sector.
The Bear Becomes a Bull
The first half of 2017 was a continuation of the energy bear market that started three years ago. But a strong recovery began in the second half of 2017. The recovery was driven by a steady decline in global crude oil inventories. That decline helped push the price of benchmark crudes from about $45 per barrel in late June to over $60 in November.
OPEC will have the largest influence on oil prices in 2018. The group recently committed to maintaining production cuts through 2018. If they follow through with that oil prices should move steadily higher as inventories continue to fall.
Who Benefits?
Along with the price recovery, U.S. oil production grew sharply in 2017 and continues to show momentum into the end of the year. Next year will likely see the previous all-time production record in the U.S. broken.
The biggest winners of an oil price recovery will be oil producers and oilfield services companies. Many oil producers have seen their share prices rise 15%-30% from the August lows.
Some upstream support services, like producers of sand used in hydraulic fracturing, have seen even bigger gains. Smart Sand (NASDAQ: SND), for instance, has risen by 70% since mid-August. Expect those gains to continue into 2018.
Natural gas producers may not fare as well, even though demand growth remains robust. Natural gas exports are surging. Consumption in the chemical sector continues to grow. Utilities are shifting away from coal and toward natural gas plants.
However, natural gas production growth has kept pace, which has kept prices in check. Continued growth in U.S. oil production also brings with it associated natural gas, and that is expected to further boost supplies next year.
Thus, unless the winter is unusually cold, the surge of oil production I expect next year should help keep natural gas prices in check. I don’t expect natural gas companies to do poorly, but they are less likely to lead the sector.
Midstream Should Catch Up As Refiners Roll
The midstream sector has lagged the oil price rally. While many oil companies enjoyed double-digit gains since August, the major midstream sector indices have declined. This disconnect can’t persist, as the outlook for the sector has improved with the increase in oil prices. Midstream is probably the most undervalued sector in oil and gas at present.
The refining sector has been in a bull market throughout the broader energy bear market of the past three years. Low oil and natural gas prices are conducive to higher refining margins. As oil companies shed 30% or more of their value since mid-2014, major refiners saw gains of 50%-70%.
If the current tax proposals pass, refiners should benefit. There is also a possibility of changes to the Renewable Fuel Standard, which costs refiners billions of dollars each year. Refiners should make further gains in 2018, but potential tax reforms could make the sector soar.
Conclusions
There are numerous potential winners in the oil and gas sector for 2018. Growth investors should focus on oil producers and refiners, while aggressive investors should look to the smaller oil producers and oilfield services companies.
Conservative investors will find a lot of value in the midstream sector. Given the improving outlook across the oil sector, integrated oil companies that encompass production, transportation, and refining should also fare well in 2018.
