Apathy Towards Energy

Crude and Products

U.S. transportation heavily relies on gas, with only 1.2% of light-duty vehicles being electric in 2022. While gas prices are down 20% from September highs to $3.10/gallon, they remain above the five-year average. Crude oil, which can be made into gasoline, also sits above its five-year average price at $82.50 (Brent).

Compelling Valuations and Shareholder Returns

Despite these above-average gasoline and crude oil prices, investors have remained apathetic when it comes to the energy sector. This disinterest in the energy space continues despite forward enterprise value to EBITDA multiples that are below historical averages. The Energy Select Sector SPDR fund (XLE) is trading at 6.1x versus the five-year average value, which sits at 6.8x.

Although these cheap valuations are not recognized fully by investors, they are recognized by players within the industry. Energy management teams have spent $442.3 billion in M&A over the past 12 months, which shows that they see value in the industry and are capitalizing on the opportunity. This is approximately 40% more activity than the year prior.¹ The two largest M&A deals were done by the two largest integrated oil companies in the United States, Chevron (CVX) and ExxonMobil (XOM). Chevron acquired Hess Corp. (HES) specifically for its Guyana assets, and ExxonMobil acquired Pioneer Natural Resources Co. (PXD), a Permian Basin powerhouse. These two monster deals added up to a staggering $127.4 billion and added billions of barrels of resources to both companies. These acquisitions are the largest deals that each of these companies have done in nearly a decade.

Not only are energy companies investing outward, but they are also investing internally through robust share buyback programs as well as dividends. In 2023 – and even 2022 – the world’s five largest publicly owned oil companies returned over $100 billion to their shareholders.² On top of elevated commodity prices and modest valuations, the current geopolitical climate as well as the continued worries surrounding energy security make the sector that much more attractive.

Chart 1: Largest Energy Deals as of October 2023

Geopolitical Forces  

The situation in the Red Sea, which is an expansion of the Israel-Palestine war, continues to involve other nations such as Iraq, Pakistan and the U.S. Over the past weekend, things have escalated with three U.S. service members killed and at least 34 wounded in a drone attack by Iran-backed militants on U.S. troops in Jordan.³ This is the first deadly strike against U.S. forces since the Israel-Palestine war erupted in October, suggesting that tensions in the Middle East are rapidly rising.

Since the onset, U.S. forces have come under attack more than 150 times by Iran-backed groups in Iraq and Syria.⁴ This has put pressure on the Biden administration to weigh a response to deter Iranian allies from conducting further attacks on U.S. forces, but without getting tied down to another war in the Middle East.

The Islamic Resistance in Iraq claimed the attacks on three bases, including the outpost on the Jordan-Syria border. The Islamic Resistance is an umbrella organization of hardline Iran-backed militant groups. They attacked a support base known as ‘Tower 22,’ which has long operated in tandem with U.S. special operations and other countries to combat Islamic State militants.

The news in the Red Sea continues to be dominated by clashes between rebel forces and the U.S. Navy. The Iran-backed Houthi forces in Yemen have been regularly attacking commercial ships passing through Red Sea waters off Yemen’s coast. In response, some shipping companies have told vessels to instead sail around southern Africa, a slower and more expensive route. According to shipping data provider ASXMarine, the number of tankers in the Suez Canal fell over 50% in the week starting January 15.⁵ We suspect the impact on shipping lanes will be heard across a few different sectors, as it could temporarily inflate costs for companies using the Red Sea as a means of transportation for their goods.

Chinese Vice Premier He Lifeng called for greater support for listed companies to help stabilize capital markets.⁶ This statement comes on the tail of last week when China announced it was cutting the reserve requirement ratio (RRR) by 50 bps to help boost the Chinese economy – the largest move it has made in two years. There has been a real effort for China to respond with fiscal support for its economy, which we believe would be supportive of global money flows. Not only will these flows benefit the multinational companies, but they will also support crude oil, as China is the second largest consumer of the product. Crude oil is a key commodity for China’s industrial production as well as its transportation industry. 

The conflict in the Middle East as well as the policy changes in China should be supportive of oil prices. The Middle East is the primary location of most OPEC+ countries, and the Red Sea is a key flashpoint for global energy trade. Now that China is cutting the RRR, the world’s second-largest economy is going to have a bigger appetite for oil and oil products. These two factors should limit supply and increase demand, benefiting the undervalued energy companies in the coming months.

Also supportive of oil prices: Warren Buffet is in the energy trade. His firm Berkshire Hathaway continues to buy Occidental Petroleum (OXY), now owning nearly 28% of the company.⁷ Although this trade may not be popular currently, we prefer to find opportunities before they hit the headlines.

Chart 2: 2022 Top Oil Consumers⁸

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Sources

1. Bloomberg. As of January 29, 2024.
2. The Guardian. As of January 1, 2024.
3. Reuters. As of January 29, 2024.
4. Reuters. As of January 29, 2024.
5. Reuters. As of January 29, 2024.
6. BusinesTimes. As of January 29, 2024.
7. Yahoo Finance. As of January 20, 2024.
8. Statista. As of August 16, 2023.