As the first quarter draws to a close, the oil and gas sector is suffering from a lack of belief:
While both exploration and production and refining stocks have greeted the apparent windfall from the commodity-market gods with a shrug, the similarities end there.
Refining stocks haven’t matched the sudden lurch in margins for the very good reason that the lurch owes something to one-off factors juicing gasoline prices in particular. Massive flooding in the Midwest has played havoc with ethanol production and logistics in general. Refinery utilization in the region is running below 90 percent so far this month, the first time that’s happened in March since 2016, when the entire oil market was in the depths of the crash. The recent fire at an oil-storage facility that sent a black plume over Houston provided a further disruptive jolt.
Against such short-term factors, the market must weigh the fact that surging light-oil production from U.S. shale is lifting gasoline yields, while domestic demand for the fuel is down slightly so far this year.
Yet refiners remain in a much better position than their upstream brethren. Compare them on virtually any time scale longer than the past few months, and refining stocks have trounced E&P stocks; on a five-year view, refiners have generated a total return of 71 percent versus a negative 55 percent return for the latter.
The reason E&P stocks haven’t matched the increase in crude oil prices is that investors are wary of such price strength lasting (we are, for one thing, nearing the zone where President Donald Trump’s tweeting thumbs get twitchy). More importantly, investors are wary of reaping the benefits of higher prices anyway. A decade of excessive spending did wonders for U.S. oil production but provided little in the way of cash payouts. It thereby blunted any option value on oil prices and pushed company valuations ever further out toward a terminal point that is beginning to intersect with projections of peak oil demand. Little wonder activists now demand cost cuts and restraint on drilling.
They also want to see any savings shared immediately; dividends are the opposite of relying on terminal values. On that front, refiners have been pointing the way for E&P stocks for a while now. The latter have just been slow on the uptake.