2023-12-19 20:38:20 ET
Summary
- Short-term market for the Energy Select Sector SPDR® Fund ETF is flat-to-bearish, with Brent futures remaining in backwardation.
- Domestic production is at all-time highs, but global demand is showing signs of a downturn, particularly in the European Bloc.
- Long-term outlook for the O&G supercycle remains positive, with expectations of increased demand and a supply deficit by 2030.
The energy industry is impacted by one exogenous event after another. The most recent event is at the geopolitical front as BP pauses shipments through the Red Sea resulting from Houthi attacks. Despite these short-term impacts, the long-term strategy for the O&G supercycle still remains. Despite this long-term outlook, the short-term market appears to be flat-to-bearish as Brent futures remain in backwardation. Though this isn’t necessarily an indicator for oil prices in 2024, it provides insight into the broader market’s sentiment towards oil prices. In this report, I will walk you through my short-term bearish sentiment as it relates to the Energy Select Sector SPDR® Fund ETF ( XLE ) as well as my long-term expectations. For a short-term strategy, I have a SELL recommendation on XLE as producers are faced with a flat oil and natural gas market with a fund price target of $75-78/share with a long-term outlook for the fund to be priced at $104/share as the long-term supercycle continues.
Macro View
Domestic production is at all-time highs, pumping out over 13mmbbl/d as of September 2023.
From the global demand perspective, the European Bloc is said to be going through a recession or at least showing signs of a downturn.
The IEA updated their 2023 estimates , suggesting that global demand for oil has reached 101.7mmbbl/d as production has surpassed demand by 200mbbl/d at 101.9mmbbl/d. Though data like this should be assessed with a grain of salt, oil pricing has certainly reflected the expectation of waning demand as global economic activity slows down. According to Reuters, the Euro Zone economy contracted 0.1% in the last quarter with December’s PMI showing a decline for every month thus far for q4’23.
US PMI readings remain relatively mixed with November manufacturing sliding further to 46.7 and Services remaining resilient but nearing the 50% mark.
Relating to the oil market, sentiment appears to be slightly negative with the Brent futures curve remaining in backwardation with the November curve pricing futures lower through 2024.
As a result, I expect some degree of domestic production curtailment to attempt to right-size supply to meet demand. I believe the industry consolidation that US producers are currently undergoing will incrementally help with production as fewer companies will control more acreage and more production volumes. Please see my analysis covering the Exxon ( XOM ) and Pioneer Natural Resources ( PXD ) deal and the Chevron ( CVX ) and Hess Corp. ( HES ) deal.
Given that Exxon and Chevron together make up nearly 40% of the total portfolio, I believe these two firms will be the primary drivers for growth and decline of the XLE portfolio. In my individual company analysis, I provided a BUY recommendation for XOM and a SELL recommendation for CVX. Pending the completion of the CVX/HES deal, I believe the core driver for each company will reside in the long-cycle Stabroek block off the coast of Guyana. This quality asset will be long-term bullish for the XLE with respect to operational efficiencies, production, and pricing.
Given the strip for 2024 Brent, I believe producers may experience a similar year of slight margin contractions and revenue decline with valuation multiples reflecting short-term decline. Looking beyond 2024, I’m long-term bullish on the domestic O&G market for a variety of reasons. Between increased LNG export capacity being built out by the end of 2024 and beyond, continued production discipline on a global scale, and industry consolidation, the long-term megatrend appears to hold.
JPMorgan Research forecasts world oil demand to reach 106.9mmbbl/d by 2030, an increase of 5.5mmbbl/d from 2023 levels. They go on to estimate a supply deficit of 1.1mmbbl/d in 2025 and expect this deficit to widen to 7.1mmbbl/d in 2030 with a long-term forecast of $80/bbl.
For comparison purposes, I recommend holding the XLE over XOP ( XOP ) as IOCs will feel less pressure from the short-term pricing cycle. In the near term, I expect the XOP to experience a stronger decline as pure-play producers are more sensitive to price declines whereas IOCs have more moving parts in operations in addition to upstream, such as refining and chemicals.
There are benefits to holding the XLE such as robust dividends as the fund’s distribution yields 3.60%, offering a strong income component. Readers should be aware that Exxon and Chevron have not cut their dividends during recent downcycles and have each focused on bolstering their balance sheets by reducing debt.
For the short cycle, I provide a SELL recommendation on the XLE with a short-term price target in the range of $75-78/share with a long-term BUY with a price target of $104/share. I will update my report on XLE regularly throughout the cycle in anticipation of the upswing. My recommendation for XOP is a SELL with a short-term price target of $114/share.
For further details see:
XLE: Short-Term Bear, Long-Term Bull