Energy: Hate it . . . but Love it

October 29, 2022

Pssst . . .

I have a secret.

Shhhhh! Don’t tell anyone.

Here it goes.

I . . .

*whew* . . . deep breath.

I . . .

*one shot . . . here goes

I HAVE TERRIBLE TASTE IN MUSIC!

Woohooo . . . it’s good to get that off my chest.

I . . . have . . . terrible . . . taste . . . in . . . music.

Yup. I said it, it didn’t need to be said, but I did.

I sadly . . . have the musical taste of a 13 year old teenage girl.

It’s true . . . and um . . . I’m not.

Okay fine, I admit, I like cheerful pop-music. Always have, always will. Katie Perry song? Yeah, I’ll sing along. Taylor Swift fan? Yeah, own it, own it, own it. N’Sync CDs? Yup, ain’t no lie . . . buy, buy, buy.

It’s a source of amusement (for my friends), bewilderment (for my wife), and deep DEEEEP unapologetic shame (for my kids).

But . . . shhhhh . . . don’t tell anyone though, this is our secret.

I can’t help it though. I get it, Vivaldi’s Four Seasons (and winter in particular) probably should exist on a higher plane . . . but still, can’t help it. I’m genetically predisposed to liking music at 116 beats per minute and sung in a third major musical key.

So why do I bring this up besides just self-flagellation? Well because I noticed something of late in our markets. Something most people don’t see because most people aren’t looking.

After writing our third quarter letter, I was revisiting some of our companies in anticipation of third quarter earnings calls and realized . . .

Y’all love bad music too!!!!

WE ARE THE SAME!!!!

In the market these days, bad music is basically energy. Eh-No-Geee. Say it like the French. Say it with dripping disdain, sorta like soup splattered onto museum pieces . . . hrmph . . . the lowest of the sectors.

Who’d want to own zat? It pollutes, it destroys . . . we get it. Environmentalists hate it and generalists shun it. For tech investors raised on a decade-long diet of moats and competitive advantages, the commoditized and cyclicality of the industry offends the sensibilities. The historically thin margins taint their spreadsheets and the sector’s activities stain their pristine ESG scorecards and green mandates.

Then again that’s precisely why we own it though. Can’t you see? It fulfills our green mandate . . . make money.

“I spittle on those cash flows.”

Do you? I mean sure, that’s the popular notion in the marketplace. Hate on energy, and yet, as I look . . . this is happening.

That my friends is the energy sector in a nutshell. Typically, energy stocks trade as a proxy to oil prices. If oil prices inflect, so do energy shares. Whether it’s smaller upstream producers (ETF: XOP) or larger multinational integrated (ETF: XLE), the general pattern is close. Makes sense.

Yet, if you look closely, it’s all beginning to dislocate. Since this summer, energy stocks have continued to rerate despite the stagnant/falling oil prices. It’s certainly not because earnings are getting better because remember, if oil prices fall, these companies make less. So it’s that other thing . . . multiple (i.e., sentiment).

Interesting right? For a sector so publicly shunned and shamed, people and their pet computers are actually starting to buy and hold the toxic stuff. I noticed it because it was a bit unexpected, and yet so utterly human. Despite the loud disdain, there’s been quiet accumulation.

Could it possibly be because of this?

Perhaps, or perhaps it’s just human nature. We all stand on principles until our soapboxes are splintered in the face of higher rates, falling liquidity and dare we say it? Underperformance.

Sacrebleu!

It’s a tough market all around and in these market battles, if your generals fall, so does your job security. So far this year, it’s only Newton’s Apple that’s successfully defied gravity.

So as we head into the Q3 earnings season for E&Ps, expect a few things. Expect cash flows . . . real cash flows. Expect dividends, share buybacks, and the fleshing-out of capital return plans. Expect tepid growth in production and slight increases in capex. Overall, expect hard-won corporate discipline to remain for the time being.

E&P companies likely won’t be too aggressive in the coming quarters simply because of the macro-uncertainty and low availability of labor, materials and capital. Moreover, they’ve only just started to appeal to a broader set of investors because of their stronger financial positions, and it’s doubtful they’ll test the loyalty at this early stage.

Investors are beginning to notice, however, and it’s hard not to when the sector is such a performance outlier this year. To be honest, we initially thought many were not going to make it . . .

Yet, maybe we’re wrong. Some investors may finally be hearing the music. So jack-in (such a quaint notion), put the headphones on and join us.

Revel in the syrupy up-beat pop-songs.

Try it you’ll like it . . .

“With a taste of your lips, I'm on a ride
You're toxic, I'm slippin' under
With a taste of a poison paradise
I'm addicted to you
Don't you know that you're toxic?”

Britney Spears - OG Energy Investor

If you’ve not had a chance, please review our Q3 Letter that we published recently. Hit the “like” button and subscribe below if you enjoyed reading the article, thank you.