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Energy Q1 Earnings Underway: Can Price Rise Quell Russia Woes?

Halliburton HAL kicks off the Oils-Energy earnings season with its first-quarter results this morning. Kinder Morgan KMI will report later in the week.

While the returns improved over the past few quarters on gradually tightening fundamentals, the January-March period witnessed several factors affecting the sector in general. From Omicron scare to inflationary pressure and the Russian invasion of Ukraine, the first quarter was not without its fair share of challenges. At the same time, oil and gas prices remained at high levels.  

Over the next month or so, as we make our way through the earnings deluge, here are some important things to look for:

Revenue & Earnings Comparison Relative to Q1 ’21

According to the U.S. Energy Information Administration, in January, February and March of 2021, the average monthly WTI crude price was $52, $59.04 and $62.33 per barrel, respectively. In 2022, average prices were $83.22 in January, $91.64 in February and $108.50 in March, i.e., much stronger year over year.

The news is also bullish on the natural gas front. In Q1 of 2021, U.S. Henry Hub average natural gas prices were $2.71 per MMBtu in January and soared to $5.35 in February before falling all the way down to $2.62 in March. Coming to 2022, the fuel traded at $4.38, $4.69 and $4.90 per MMBtu in January, February and March, respectively. In other words, natural gas traded noticeably higher in two of the three months.

The significant year-over-year improvement in commodity prices paints a rosy picture for the Q1 earnings season. Per the latest Earnings Trends, Energy is on track for a big earnings boost compared to a year earlier. Per our expectations, the sector’s bottom line is likely to have surged 209% from first-quarter 2021 on 38.2% higher revenues.

How Will the Sub Industries Perform?

From upstream (exploration and production) to midstream (pipelines) to downstream (refining and distribution), let’s see how the different subsets of energy might have performed in the March quarter.

While the price boost will buoy the results of E&P companies for obvious reasons, refiners’ numbers are likely to benefit from healthy margins (especially for distillates) on the back of a continued rise in product demand. However, high costs, maintenance-related outages, hedging impact and comparative margin softness in regions other than the United States might put a drag on the profitability of the downstream operators.

Meanwhile, though the E&P capital discipline is set to continue in 2022, oilfield service firms like Halliburton — that make it possible for upstream players to drill for oil and gas — are likely to have gained from an increase in onshore drilling and completion spending during the first quarter. The rebound in domestic production has led to an improvement in service fundamentals, leading to higher prices for HAL and its peers.

With rig count improving considerably and completion activity in North America on the upswing, Halliburton expects its market-leading hydraulic fracturing business to come up with strong numbers in the to-be-reported quarter.

Finally, the pipeline companies are expected to have capitalized on stabilized production and rebounding energy demand, riding on an increasingly vaccinated economy. In other words, the macro environment for energy infrastructure providers remained favorable during the first quarter, with earnings improvement expected versus last year.

The Russian Impact

Investors will be watching closely for a possible hit to the quarterly results after a number of energy companies ceased operations in Russia following Moscow’s invasion of Ukraine.

For example, Shell plc SHEL said it would take a $4-5 billion hit in the first quarter of this year. The London-based energy biggie informed that apart from the cost of exit, the charges include other associated effects like loss of value on assets, non-payment of obligations and other credit losses.

Seeking to distance itself from the country, Shell stated last month that it is withdrawing from the Russian oil and gas industry in a phased manner and is instantly discontinuing all spot purchases of Russian crude. Shell, however, maintained that the charges, which were previously thought to reach some $3.4 billion, won’t impact adjusted earnings.

What’s the Outlook for Dividends/Distributions?

As oil has come back strongly, the sector components have reacted positively to this robust investment landscape.

Cash from operations is on a sustainable path as revenues improve and the companies slash capital expenditures from the pre-pandemic levels amid sharply higher commodity prices. To put it simply, the environment of strong oil prices has helped the energy operators to generate significant “excess cash,” which they intend to use to boost investor returns.

For energy investors, the recent dividend hike by hydrocarbon producer Murphy Oil MUR, among others, represents a tangible proof point of continued positive changes for the space in recent quarters. Earlier this month, MUR — carrying a Zacks Rank #1 (Strong Buy) — got approval from the board of directors to increase the quarterly payout by 17% to 17.50 cents per share.

You can see the complete list of today’s Zacks #1 Rank stocks here.

The decision by Murphy Oil management is seen as the path to return a higher percentage of cash flow to investors. While MUR’s dividend increase is one of the choices to ride the commodity price boon, Chevron CVX delighted investors with stock buyback news.

At its annual investor meeting last month, CVX promised anything between $5 billion and $10 billion worth of buybacks each year. At the midpoint, that’s almost double the supermajor’s previous range of $3 billion to $5 billion. Management’s commitment to pledge more money to shareholders highlights surging oil and gas prices that have allowed Chevron to harvest bumper profits.

It should come as no surprise if more energy companies decide to follow Chevron and allocate the increasing cash pile in the first quarter to pacify the long-suffering shareholders.

The major midstream players like Kinder Morgan, largely insulated to fluctuations in commodity prices, managed to maintain their distribution levels through the crisis-stricken 2020. With a far stronger midstream payout scenario now based on their relatively steady coverage and surging oil/gas realizations, cash flow visibility is even greater for the first quarter.

A case in point is KMI’s 3% year-over-year dividend increase for the fourth quarter (to $1.08 annualized) and the subsequent guidance that projects the annual dividend this year at $1.11 per share.

Shale Producers in the Spotlight

Most indicators show that energy is in the midst of a long-term upcycle. Taking investors on a roller coaster ride, crude has made a massive rebound from the depths of minus $38 a barrel in April 2020 to a multi-year high of $130 in March. With this firmed-up price, shale operators could surprise on the upside.

As the output from the unconventional plays looks set for an uptick, all eyes will be on the companies working in the Permian Basin — America’s hottest and lowest-cost shale region, and by far the primary driver of crude production in the United States. The improvement in oil prices has prompted these firms to shore up drilling activity, leading to improved cash flows and increased chances of an earnings beat. One thing that might concern many investors though, is spiraling cost inflation.

Keep an Eye on Financial Guidance

Since the coronavirus-induced depths of 2020, the sector has staged a stunning recovery on rebalancing supply/demand fundamentals. While there’s some concern about the impact of the Russia-Ukraine war on certain businesses and rising inflationary expectations, we expect the positive momentum to have been carried into the first quarter on solid demand dynamics.  

The quarterly announcements will also present an opportunity for the companies to highlight their plans of using the substantial free cash flows — whether to strengthen the balance sheets or pay cash back to shareholders. With the macro backdrop still encouraging amid optimism around the demand picture, investors will be looking forward to company-level improvements in the outlook.

An effective way to gauge a firm’s strength and resilience is to look out for improved guidance. Of particular interest will be the cost-reduction initiatives, updates on free cash flow, and upward revision in estimated production.

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