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Halliburton HAL kicks off the Oils-Energy earnings season with its second-quarter results today. Kinder Morgan KMI and Schlumberger SLB will report later in the week.
While the returns improved in the third and fourth quarters of 2020 on gradually tightening fundamentals, the January-March period further reinforced the sector’s stability. The second quarter should be even better as commodity prices have rebounded sharply, revisiting their multi-year highs following the vaccine progress and the ongoing macroeconomic recovery.
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 Q2 ’20
According to the U.S. Energy Information Administration, in April, May and June of 2020, the average monthly WTI crude price was $16.55, $28.56 and $38.31 per barrel, respectively. In 2021, average prices were $61.72 in April, $65.17 in May and $71.38 in June, i.e., much stronger year over year.
The news is also bullish on the natural gas front. In Q2 of 2020, U.S. Henry Hub average natural gas prices were $1.74 per MMBtu in April and rose marginally to $1.75 in May before tumbling to $1.63 in June. Coming to 2021, the fuel traded at $2.66, $2.91 and $3.26 per MMBtu, in April, May and June, respectively. In other words, natural gas traded noticeably higher in all the three months.
The significant year-over-year improvement in commodity prices paints a rosy picture for the Q2 earnings season. Per the latest Earnings Trends, Energy is on track to have positive earnings compared to losses a year earlier. Per our expectations, the sector is likely to have trended back to profitability from second-quarter 2020 loss on 78.8% 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 June quarter.
While the price boost will buoy the results of E&P companies for obvious reasons, the refiners’ numbers is likely to have remained weak. Fuel usage has recovered on increased mobility — reflected by rising refinery utilization and margin numbers — but jet fuel demand is yet to reach the pre-pandemic levels. Thus, refining profitability is still well below five-year averages.
Meanwhile, the E&P capital discipline is likely to continue through 2021, which automatically translates into lesser work for the oilfield service firms — companies that make it possible for upstream players to drill for oil and gas. Agreed, the rig count has recovered considerably, costs have been slashed and completion activity is looking up too but overcapacity and pricing pressure (specially on the input side) would restrict the positive impact.
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 second quarter with significant earnings improvement expected versus last year.
What’s the Outlook for Dividends/Distributions?
As oil has come back strongly, the sector components have reacted very 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.
While the likes of Equinor ASA EQNR and Marathon Oil MRO — carrying a Zacks Rank #1 (Strong Buy) and 2 (Buy), respectively — announced plans to raise dividends during the first-quarter release, BP plc BP and ConocoPhillips COP delighted investors with stock buyback news. It should come as no surprise if more oil producers decide to allocate the increasing cash pile in the second quarter to pacify the long-suffering shareholders.
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The major midstream players — being largely insulated to fluctuations in commodity prices — managed to maintain their distribution levels through the crisis-stricken 2020. Further, their relatively steady coverage and improving commodity price visibility should represent a more predictable midstream payout scenario in the second quarter.
Shale Producers in the Spotlight
Most indicators show that energy could be on a steady recovery path. During the second quarter, crude found strong support at around $70 a barrel, with the U.S. benchmark hitting a more than two-and-a-half-year high above $74 in June. With this firmed-up price and some previously shut-in production coming back online, shale operators could surprise on the upside.
As output from the unconventional plays look 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.
Keep an Eye on Positive Financial Guidance for the Second Half
Since the coronavirus-induced depths of a year ago, the sector has been staging a recovery over the past few quarters on rebalancing supply/demand fundamentals. We expect the positive momentum to have been carried into the second quarter based on the improving outlook for the global economy and oil demand.
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 most encouraging macro backdrop in months and optimism around the vaccines, investors will be looking ahead 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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BP p.l.c. (BP) : Free Stock Analysis Report
Schlumberger Limited (SLB) : Free Stock Analysis Report
Halliburton Company (HAL) : Free Stock Analysis Report
ConocoPhillips (COP) : Free Stock Analysis Report
Marathon Oil Corporation (MRO) : Free Stock Analysis Report
Kinder Morgan, Inc. (KMI) : Free Stock Analysis Report
Equinor ASA (EQNR) : Free Stock Analysis Report
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