Market Commentary: Reality vs. Bad Optics
Updated: Aug 22, 2021
Energy is leading the market higher in 2021 and our Infrastructure Income Strategy is a major
beneficiary. Our Portfolio returned 4.1% in January versus a 1.1% loss for the S&P 500. The midstream and renewable stocks had strong gains that were partially offset by the underperformance of our utility holdings. We believe that our strategy offers a compelling value proposition with a current yield of 6% and 3-4% potential growth in income.
The momentum has continued in February in the face of headwinds from a Biden administration that appears opposed to the U.S. oil and gas industry. Despite the decision to shut down the Keystone XL pipeline project, plans to rejoin the Paris Accord and executive orders restricting drilling on federal lands, the actual impact of these actions to the oil and gas sector is likely to be inconsequential for at least the next few years. Hence, the energy stocks momentarily dipped in January until investors could separate reality from bad optics.
Where we stand - The midstream sector still offers meaningful long-term price appreciation potential. Our positive outlook is supported by the sector’s free cash flow generation in 2021 and beyond, the improving outlook for economic growth and higher projected energy demand. We are also bullish on the long-term growth potential of renewables and continue to look for new companies to add to our portfolio. However, we are mindful of valuations and will only include opportunistically. In addition, we view utilities that are growing their renewable footprint favorably. Although the sector has lagged,
valuations appear attractive and our utilities exposure provides portfolio diversification that reduces risk, in our view.
The macro narrative for Midstream is favorable and trumping, in our view, the overly pessimistic perception concerning the future demise of oil and gas investments. Visible prospects for economic growth due to vaccines taming the COVID-19 beast and ongoing fiscal stimulus and easy monetary policy; the rebound in oil and natural gas prices; potential for the reappearance of inflation and ongoing rotation from growth to value - have helped to push midstream stocks higher. To paraphrase Mark Twain, “the rumors of the impending death of the oil and gas industry are greatly exaggerated.”
● Oil prices have rebounded to pre-pandemic levels and have broached the $60 per
barrel level. As of 2/16/21, Brent (the international crude benchmark) and WTI prices
closed at new 52-week highs at $63.50 per Bbl and $60.05 per Bbl, respectively. This is
simply a function of supply and demand. Saudi Arabia and OPEC plus are doing a
wonderful job restricting supply while producers in the U.S. are displaying financial
discipline. Drilling activity in the U.S. has rebounded to a level that will maintain or only
marginally grow production as domestic producers (primarily public companies) are
living within cash flow. They are focused on de-leveraging, returning cash to
shareholders and earning returns on investments above their cost of capital.
● Global oil demand has rebounded from its trough of 82.9 MBbls/d in Q2’20 to a
projected level of 94.7 MBbls/d in Q4’20, down just 5.9 MBbls/d from peak
consumption in Q4’19. According to the International Energy Administration (IEA)
projections, Asia is already back to pre-pandemic levels and global consumption overall
should approach its prior peak in Q4’21.
● Potential global economic growth revised higher. Also cited in its February Oil Market
Report (OMR), the IEA noted in its January update that the IMF raised its forecast for the
world economy in 2021 to 5.5% (from 5.2%) and its U.S. GDP forecast by 2% to 5.1%.
The economies of China and India are forecast to grow by 8.1% and 11.5%, respectively,
in 2021 and fuel the ongoing resurgence in oil demand.
● Natural gas prices have also firmed. Spot natural gas prices have once again moved
above $3.00 per MMBtu. This has been driven by higher demand due to colder weather,
the resumption of growth in liquefied natural gas (LNG) exports coupled with a decline
in supply (lower U.S. production). To note, prices averaged just $2.03 per MMBtu in
2020 and averaged only $1.71 per MMBtu in Q2’20. In its February Short Term Energy
Outlook, the EIA forecasts that U.S. natural gas production will stay relatively flat
through 2022 - averaging 90.5. Bcf/d and 91.0 Bcf/d in 2021 and 2022, respectively. This
is modestly lower than the 91.3 Bcf/d produced in 2020 and 93.1 Bcf/d in 2019.
Exhibit 1. Price Performance Since 2019
Source: S&P Global, NASDAQ and Alerian