PXE - PXE: Searching For A Balance In The Cycle

2023-05-22 12:23:22 ET

Summary

• Since the beginning of 2023, the anticipated oil supercycle has lost its bullish momentum.
• Although crude benchmarks briefly surpassed the $100 mark in 2022, it was a temporary surge, and the lack of immediate catalysts dampens the overall outlook for the E&P industry.
• In comparison to the broader market and crude prices, the sector now appears overstretched.
• As economic growth slows and inflationary pressures ease, the E&P industry faces downward pressure in the short to medium term.

Investment Thesis

The anticipated commodity supercycle, particularly for oil, has lost its bullish momentum since the start of 2023. Although crude benchmarks surpassed the $100 mark in 2022, that was just temporary and the absence of short-term catalysts dampens the overall outlook. Exploration and production (E&P) stocks saw significant gains in the past 18 months due to attractive valuations and materialized catalysts. However, relative to the market and crude prices, the sector appears overstretched now. With economic growth slowing and inflationary pressures easing, the E&P industry faces downward pressure in the short to medium term.

About PXE

The Invesco Dynamic Energy Exploration & Production ETF (PXE) is a popular exchange-traded fund that provides investors with exposure to the energy exploration and production sector. PXE is designed to track the performance of the Dynamic Energy Exploration & Production Intellidex Index, which consists of U.S. companies engaged in the exploration, production, and distribution of energy resources.

By investing in PXE, investors gain exposure to the dynamic and evolving energy exploration and production sector, which can be influenced by factors such as changes in oil and gas prices, technological advancements, regulatory developments, and geopolitical events. The fund offers a convenient and efficient way to access a basket of energy-related stocks, providing diversification and potentially capitalizing on opportunities within the sector.

The table below summarizes PXE's top holdings. For further information on this product, it's very important to check Invesco's website and PXE's prospectus .

A Different View on PXE

Since the start of 2022, there have been many calls pointing to a commodity super cycle, with a particular emphasis on oil prices. While bulls have been correct in their assessment that the major benchmarks for crude would spike above the $100 threshold in 2022, I think that the overall picture is less bullish today given the lack of short-term catalysts to take oil prices higher. Exploration and production (E&P) stocks did particularly well over the past 18 months, given the very low levels at which they were trading at the start of the bull market and the numerous catalysts that subsequently materialized.

However, I believe that despite the attractive valuations and fundamentals, the sector is overstretched relative to the market and to the price of crude oil. As a result, I wouldn't be surprised to see the current downtrend continue until PXE trades in the low 20s per share. If we just take a look at the relative performance of PXE versus the WTI over the past 24 months, the correlation weakened after June 2022, which represented a local top for the WTI. I expect to see this gap close out over the next 12 months.

2022 has been the kind of year when all stars aligned for the Bulls. From a war in the center of Europe involving one of the largest oil producers to strong economic growth in most countries around the world, this has turned out to be the perfect mix for oil prices to rip higher. Evidence of how stretched that market was could be seen in cracks where we have experienced moves exceeding three standard deviations higher between March and June 2022.

However, with the exception of a few products like gasoline, cracks are now normalizing to lower levels, which is in my opinion a sign of a market that is more balanced. In this context, lower crack spreads are likely to reduce refinery demand for crude oil, affecting the overall market balance, and impacting the E&P complex.

Another feature of 2022 is the fact that the conflict in Ukraine had cross-asset ramifications. Instead of being an affordable substitute for crude oil to generate energy, natural gas became more expensive than Brent in Europe for most of 2023, which pushed many energy-intensive industries to switch from natural gas to diesel for a short period of time. This trend has now reversed, and oil Bulls have lost another tailwind to support higher crude prices, which in turn justifies higher capex. This is in my opinion another bear flag for the E&P industry.

Another indication that points to a market that is very well supplied is the front spread. WTI front spreads have been indicating a shift from a market in backwardation to a contango structure for the past 2 quarters, while the swap curve based on dated Brent is showing contango in the spot. I don't think this market needs more crude at this point, I believe it actually needs less, and this view seems to be shared by OPEC given this year's cuts. Let's keep in mind that we're now in a balanced market, but GDP is still running at nearly 3% annualized . Assuming growth takes a hit, this could turn ugly for E&P stocks, as it usually does when growth decelerates.

And growth will at some point slow down, especially once interest rates start impacting it. Moreover, the unemployment rate is currently the lowest it has been in decades, and this will also reverse, as it happened in past cycles. Record-high consumer spending has been a major driver of the E&P sector's renaissance, and a cooling down of the economy is not something bullish at this point. The favorable economic momentum is slowly turning since March 2023, likely due to the challenges faced by the regional banking sector. As the economy slows and inflationary pressures ease, crude prices will come under pressure, negatively impacting PXE in the process.

Key Takeaways

Since the beginning of 2023, the anticipated oil supercycle has lost its bullish momentum. Although crude benchmarks briefly surpassed the $100 mark in 2022, it was a temporary surge, and the lack of immediate catalysts dampens the overall outlook for the E&P industry. Over the past 18 months, E&P stocks experienced substantial gains, benefiting from attractive valuations and numerous catalysts. However, in comparison to the broader market and crude prices, the sector now appears overstretched. Moreover, as economic growth slows and inflationary pressures ease, the E&P industry faces downward pressure in the short to medium term.

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