2015 was a rough year for energy, filled with drama, uncertainty, and rough, rough performances across the board.
On this episode of Industry Focus: Energy, Motley Fool analysts Sean O'Reilly, Taylor Muckerman and Tyler Crowe throw around their ideas about how the sector looks in for 2016. Can oil bounce back? Can coal? Natural gas? What companies need to get their act together, and who's been on their game throughout last year? How much should we worry about OPEC cornering the market, and what other factors might affect the price of oil? Listen in to hear their takes on these issues and more.
A full transcript follows the video.
This podcast was recorded on Dec. 21, 2015.
Sean O'Reilly: Will 2016 be kinder to energy companies, on this energy edition of Industry Focus. Greetings, Fools! I am Sean O'Reilly, joining you here from Fool headquarters in Alexandria, Virginia. It is New Year's Eve, December 31st, 2015, in joining me to ring in the new year is Tyler Crowe and Taylor Muckerman. Happy New Year, guys!
Taylor Muckerman: You too.
Tyler Crowe: Happy New Year! Well ... not quite yet.
O'Reilly: Any resolutions you're going to make?
Crowe: Are we going to talk about our energy resolutions for the New Year?
O'Reilly: Oh, that's good! Are we?
Crowe: Maybe. We'll see at the end.
O'Reilly: Alright, fine, we'll wait. Well, we learned last week that we all have horrible track records about predictions, like everybody else. But ...
Crowe: Let's make some anyways!
O'Reilly: Yeah, why not! Let's just do it, who cares.
Crowe: Everybody loves predictions and then being like, "Shame! You were wrong!"
Muckerman: As long as we admit up front that we don't believe in them, it's fine.
O'Reilly: Yeah, I'll just add a little disclosure -- nobody make any decisions based on the next 20 minutes.
Crowe: None whatsoever. This is purely for entertainment purposes only.
O'Reilly: So, Taylor. What trend are you watching in 2016?
Muckerman: So, I don't know if it's a trend, but I'm wanting to see if Saudi Arabia is going to back down, if they're going to decide, "Maybe producing as much as we're producing isn't the best idea for everybody."
O'Reilly: But Taylor! They're trying to capture market share!
Muckerman: I know! Maybe they do it alone, maybe they convince Russia and Iraq to hop on board.
O'Reilly: That's what they actually want, they want to get the Russians in on it.
Muckerman: Because Russia's producing at record levels, and Iraq's producing at record levels, and so is the United States -- but they know we're not going to back down. So, I think, eh, maybe they can convince Russia or Iraq to do it. Or, maybe they could just realize they're going a little overboard right now.
O'Reilly: If they don't do something ... what's the point of OPEC if they're going to leave things to market forces? What's the point?
Muckerman: There isn't a point to it after this last meeting.
Crowe: They've even admitted there's no point.
Muckerman: Yeah, it's just like a party twice a year. And they only met for like seven hours, then got the hell out of there.
Muckerman: Yeah. And they said that was a long meeting.
Muckerman: It was a Friday meeting, and then they all left.
Crowe: It was in Vienna. I guess none of them are really into skiing, because I could find something to do in a weekend in Austria.
Muckerman: They said they all left angrily and got on their private planes and flew back to their countries. Yeah, I don't know what the point of it is. Maybe it's a cigar club.
Crowe: For sheikhs.
Muckerman: Well, no, you have Venezuela in there, they're not very sheikh-y.
Crowe: The most politically correct of the Industry Focus shows.
Muckerman: I mean--
Crowe: I'm just screwing with you.
Muckerman: So, that's my ... maybe not a trend, but I'm hoping to see their opinion change.
O'Reilly: Got it. Tyler?
Crowe: This is a two-year continuation, almost, of something I've been watching since 2013. It was a prediction I made back in 2013, and everybody was like [GRUMBLES]. I said back then, "A coal company is going to go bankrupt, one of the big ones." And you had one go. And last year, I said, "Another one's going to go bankrupt," because if you look at the market forces that are attacking coal right now, it seemed prime for it. There were a lot of debt-laden companies.
And lo and behold, who was it? I think Alpha Natural Resources, this year, did. And going into 2016, the market conditions for coal have not improved at all in these past couple years. In some ways, it's actually gotten worse. The price of coal is still going down. And looking at the pressures that are being put on coal--
O'Reilly: Including natural gas.
Crowe: I'm not talking about environmental regulation pressure. I'm talking purely about switching costs to a more economical source, such as natural gas--
O'Reilly: That also happens to be cleaner.
Crowe: That happens to pass muster. So they say. Yeah, you can make the arguments on leaks of methane and things like that with natural gas. But just looking at it purely from a market standpoint, natural gas is, I believe, actually below $2 per 1000 cubic feet right now, trading at Henry Hub. And when you have prices that low ...
O'Reilly: I have $20, can I get 10,000 cubic feet?
Crowe: You can.
O'Reilly: Hell, I have $40.
Crowe: You could start arbitraging natural gas with that much money, that's how cheap natural gas is. So, when you have that much pressure being put on the coal market ... and there's still a lot of debt-laden companies in this space. I want to watch this year if we see an even larger correction in terms of other companies pulling the plug, scaling back production, and just really ripping the bandage off really harshly. I'm looking at companies like Peabody Energy (BTU), largest coal producer in the United States, been hemorrhaging money for years. And they've not been able to cut production enough to bring the market back into balance. I'm fascinated to see what happens with this market.
O'Reilly: Peabody's got a market cap of $140M, and it's the largest coal company in the United States?
Crowe: I believe, if you were to go back and look at that, they're down like 98%, 99% since 2011.
O'Reilly: Yeah. Did they do a reverse split there to get to $7? That's what their stock is.
Crowe: Yes, they did.
O'Reilly: Yeah. I was like, "There's no way."
Muckerman: Speaking of that, I think Halcon just did a reverse split.
Crowe: Of course they did.
Muckerman: They were in the $0.20 range or something like that.
O'Reilly: Yeah. All you need to do is do a reverse split. So, moving on to the story that everyone really wants to know about -- will oil finally rebalance? And will the price go up in 2016? Who wants to go first?
Muckerman: What do you mean by rebalancing?
O'Reilly: Well, supply and demand. Because it fell, supposedly, because we had too much supply. So there's that.
Muckerman: It might come close, but I don't think prices are going to breach $60 or $70 per barrel. But I wouldn't be surprised if the sector is a top three, top five performing sector in the market, for investors.
O'Reilly: Motion seconded. Tyler?
Crowe: So much of what we talk about, oil and gas, its ability to rebound, it's always to talk about, "Will Saudi Arabia produce/not produce? What's going to happen here?" But one of the most critical things, and we were talking about this before the show, is the difference between the physical properties of oil reservoirs and the amount of investment that goes into the sector.
This past year alone, $220B worth of investment has been pulled out of energy. And I'm not talking about on the markets, I'm talking about companies scaling back capital expenditures. So, that much less money is getting poured into reinvigorate reservoirs, drill for new oil.
O'Reilly: These aren't just shale drills. These are long-tail big projects.
Crowe: And if you look at the decline rate across the world, you're looking at a decline without reinvestment of 3-4%. And as that declines and demand does increase, you're going to get a rebalancing. And at the levels of spending, there's been a lot of analysis on the difference in spending, what it's going to mean for production projection from people.
The widely held belief that the market will rebalance toward the end of 2016, in terms of how much is being supplied and how much is actually in demand. So, what that means for prices, I don't have the slightest of clue, and I don't think anybody in this room, in this building, in this state, or in this country, or even on this planet, knows.
O'Reilly: Taylor, you're killing me. But, that's what's been driving me crazy this year, you have Goldman Sachs and these guys making price predictions, and it's like, all of you were calling $90+ right before the crash started in November 2014. All of you thought $85, $90!
Muckerman: That's how it always happens. Changing sectors, people just started writing off GoPro. They were loving it when it IPO'd then after it dropped like 70%, now everyone hates it.
O'Reilly: Now it's a sell.
Muckerman: It happens with every company. All the price targets are lowered after the price of the actual good or stock is lowered. They raise their price targets, it's all momentum-based, no one gets out in front of these things. Goldman actually thinks oil will hit $20, or could. Like you just said, $90 predictions to a $20 prediction.
O'Reilly: Everybody thought $90 forever.
Crowe: Goldman might actually be the prototypical case of, better to be lucky than to be good, because right around January of this year, 2015, they said oil was going to trade below $40, that it was going to be in the $35-40 range. And a lot of people said they were crazy. And they laid out a ton of reasons why they thought it was going to happen, but, if you look at what has happened this year, the reasons that we're at that level aren't correlated with what Goldman Sachs said.
O'Reilly: It's probably more that they got lucky that OPEC and Saudi Arabia ...
Crowe: It's better the be lucky than good. Maybe, there somewhere at Goldman Sachs that they're running around giving each other high fives in the office, and they're planning a super awesome Christmas party, like, "Yeah, we nailed this one!"
Muckerman: "Everything is awesome!"
O'Reilly: "Everything is cool when you're part of Goldman Sachs!"
Muckerman: Nice riff.
Crowe: I really, really hope they use that. I want that to be their jingle on all of their commercials, that'd be great.
O'Reilly: Do they have commercials?
Crowe: No, probably not.
O'Reilly: They could make that as part of their intern introductory videos, though.
Muckerman: Drink the Kool Aid.
O'Reilly: Now, before we go on to talking stocks for the next year, I wanted to point our listeners to the newly redesigned focus.fool.com. There, you'll discover a special offer to join The Motley Fool Stock Advisor newsletter for all Industry Focus listeners. All loyal IF listeners have access to a special discount on Stock Advisor that works out to $129 for a full two-year subscription. And if you join, as part of your Stock Advisor subscription, you can check out exclusive content from Tyler Crowe and I's recent trip to Houston, Texas, where we interviewed executives from National Oilwell Varco and DistributionNOW (DNOW 1.24%). That was a pretty good time.
Crowe: Great time.
O'Reilly: Hung out in Houston.
Crowe: We'll talk about it the next couple weeks here.
O'Reilly: Weather was great.
Crowe: It wasn't.
O'Reilly: Oh yeah, it rained, right.
Muckerman: That was your other trip to Houston.
O'Reilly: Yeah. Hopefully we'll go again soon. Alright, guys, 2015 was rough for everybody's energy portfolios. I'm interested to hear what stocks need to prove it to you in 2016. So, not only just perform well, operationally or otherwise. But, you don't trust them to execute in the current environment.
Muckerman: Royal Dutch Shell (RDS.A) (RDS.B).
O'Reilly: You don't trust the Dutch?
Muckerman: I mean, they just spent $70B on an acquisition. I don't think it's going to pan out.
O'Reilly: You didn't agree with the acquisition?
Muckerman: I mean, they upped their reserves by 25%, but they spend $71B to do it. They're a little bit more into the LNG game with this company, but their locations don't overlap. LNG could be the future, but it's not 2016. So, I think some write downs could occur. They've already announced over 10,000 layoffs through this deal. So, they're cost cutting. Who knows if that's because of efficiencies or because they need to. So, I think 2016, Royal Dutch Shell is going to have to prove it.
O'Reilly: Mr. Crowe? Who needs to prove it to you?
Crowe: There's so many companies, do I have to just pick one?
O'Reilly: If I'm reading you right, the whole sector needs to prove it to you?
Crowe: No, not the whole sector. I think there's some good apples in there. But, independent oil and gas producers in the United States.
Muckerman: That was my first runner up.
O'Reilly: Prove it.
Crowe: There's a couple good ones that have shown that they can be profitable, well-managed, can keep themselves from getting in too much debt trouble. I think EOG Resources (EOG 7.20%) is a good example of it. For all these other guys who lived under the world of cheap financing, expensive oil, basically the perfect conditions to produce oil, and give yourself a springboard to become responsible managers.
Well, now, you've been punished. And now you need to prove to us in 2016 that you can more responsibly handle the shale situation, improve efficiencies, find a way to be a profitable business on a free cash flow basis, and actually run in that sort of way. And until I see that, I'm still going to be very skeptical, at least in my own personal investing, in investing in independent E&Ps.
Muckerman: Do you learn, or does it rhyme with history, is what we're trying to decide. The land grab is over. That was a big part of it. They had to drill to keep their acreage, that's over.
Crowe: You can't lean on that anymore, that's for sure.
O'Reilly: So, on the completely opposite end of the spectrum, from your very deep and insightful analysis of why or why not E&P producers domestically should exist, I want to do some harebrained predictions, just absolutely crazy predictions for 2016.
O'Reilly: Will Saudi Arabia cut by 5 million barrels per day?!
Crowe: Here's mine, and I'll make some enemies when I say this -- the Halliburton (HAL 1.91%) / Baker Hughes (BHI) merger will not happen.
O'Reilly: Because of regulators, I assume.
Crowe: A combination of things.
Muckerman: It's been over a year.
Crowe: Yeah, it's been over a year in the making already. It was already announced earlier in December that they were pushing the final decision date all the way out to April 30th, because now, the U.S. antitrust is starting to sink its teeth into it. We had talked about this a couple of months ago when Australia and Europe started talking about antitrust, and now the U.S. This combined company would have the largest market share, so the antitrust is really starting to sink their teeth in and say, "We don't really like the looks of this."
And so, my thing is, not only do I think it's not going to happen, but I don't think they should do it, considering all the antitrust. My biggest fear for them would be is, they do it, they have to strip the cupboard of all the business segments they have, and basically go back to the size that Halliburton was before the merger happened anyways, and it just doesn't seem worth it to do it. If they were to go through with it -- again, I think they're going to strip themselves down of so many profitable businesses ...
O'Reilly: To satisfy the regulators.
Crowe: Yeah. And it's not going to make it worth it in the first place. So, my guess is it doesn't happen, Halliburton gives up and shells over $3B to Baker Hughes as a "thanks for your time," and they move on.
Muckerman: Buy Baker Hughes.
O'Reilly: Is that your crazy prediction?
Muckerman: No, Halliburton tried it. It might not work. No, if they get $3B in cash, though ... that's not too bad of a little windfall. My hare-brained prediction is that the summer of 2016 Olympics is a complete debacle because Petrobras and Vale and all these other companies can't fund Brazil's ...
O'Reilly: Oh my gosh. This might not actually be that crazy.
Muckerman: I saw the other day that they're planning on making athletes pay for their own air conditioning.
O'Reilly: Man, that's good. If you were to go pick some lottery numbers right now ...
Crowe: And it's not just that--
Muckerman: Their power, their infrastructure is shite, they run out of power because it's all build on water, so if there's a drought ...
Crowe: Yeah. I do some coverage for the premium side, and they had some investments in Brazil for one of the ones, and what it brought us to is, if you look at some of the water-related events, like white water rafting and things like that, they're in polluted, polluted water. It's gross. It's almost to the point that we can't afford to clean it up to get it ready. How great is it going to be--
O'Reilly: The Olympics are an expensive affair, too.
Muckerman: Yeah. They can't just reuse the World Cup stadiums they built. They have to build all new stadiums.
Crowe: Right. And it's all in Rio, it's not like it's spread across all of Brazil. This is in a country where the president is very, very possibly going to get impeached.
O'Reilly: This is really good.
Muckerman: Yeah, all of their money comes from resources, and resources are in the tank, and they've been in the tank.
O'Reilly: Muckerman for Prez. That's good.
Crowe: Yeah, I like that one. And way to tie it into the energy sector, too. I was like, "Where is he going with this?"
O'Reilly: "Reaching." I do have a crazy one.
Muckerman: Lay it on us.
O'Reilly: I think that there's going to be a modest supply disruption somewhere in the Middle East with one of the major oil producers. My crazy prediction is that you'll get a big spike in oil because of it.
Muckerman: Interesting you say that. In the world we're living in right now with crazy production, ISIS ... if you had ISIS like five years ago, even three or four ...
O'Reilly: Oil would be $150 or something.
Muckerman: Through the roof. They're disrupting Iraq's and Syria's oil production and supply lines. Egypt is not a very big producer at all. When they had their Arab Spring, prices were going nutzo. And prices continue to fall.
O'Reilly: Yeah, and none of that is happening now.
Crowe: I can actually remember, a couple years ago, and I almost kick myself for having that thought and not really thinking it through, we were at a time where it wasn't ISIS specifically, but there were major disruptions in Iraq because of civil conflict, they were holding back production. We had Iran that was held back by sanctions. Libya had basically shut down. Nigeria was under force majeure for a lot of its exports with companies like Shell because of theft--
O'Reilly: And Nigeria alone is begging OPEC for higher prices right now, by the way.
Crowe: --so, we had this whole situation, and oil prices weren't moving. It was in the $90-100 range for a couple years, with all of these things happening. My short-term thinking at the time was, "Wow, America's done an amazing job here keeping oil prices where they were--"
O'Reilly: But you should have been bearish, is what you were saying.
Crowe: It should have been $200 per barrel, based on all that conflict that was going on. But for some reason, the thought was, "What if all those guys did come back?"
Muckerman: Yeah, what if they're all producing at once?
Crowe: And that's what's happening now. Even Libya is still well under production capacity.
O'Reilly: Right. If they came back, there'd be another -- anyways, my thing is, you look at how much we're over-supplied, correct me if I'm wrong, it's 1M, 1.5M, something like that--
Muckerman: Of what we're actually producing.
Muckerman: Of what we could produce, we're oversupplied by probably 5M to 10M.
O'Reilly: Right. You get a decent supply disruption, and boom, that goes away.
Muckerman: It'd have to be pretty major, I think.
O'Reilly: But, you know, ISIS does something crazy ... I don't know.
Muckerman: They're already doing crazy stuff. With the oil, though, yeah.
O'Reilly: So, that's my hare-brained idea.
Crowe: So, there we go, people. We've got Halliburton-Baker Hughes not happening, 2016 Olympics in the tank--
Muckerman: In shambles.
O'Reilly: That's a good one. I really do like that.
Muckerman: It's been a slow burn. People thought China Summer Olympics were going to be terrible because of pollution, people thought Russia Winter Olympics were going to be terrible because Sochi wasn't a winter city.
Crowe: You think that's bad? What about Beijing's Winter Olympics in 2020? 2022? Can't remember which one. As somebody who's an avid winter sports guy, I am dreading the Beijing Olympics.
O'Reilly: It'll all be fake snow, don't you worry. Alright, so, before we go, before we ring in the New Year, top stock picks in 2016.
Muckerman: Oof, woof. Woof.
O'Reilly: Well, you said you're relatively bullish on the sector.
Muckerman: Yeah, I'm relatively bullish on the sector. I don't know what the whole market's going to do, but I think it'll, in relation to all the other sectors, perform well. Whether it produces positive returns or not, I don't know. But my top stock, because of the low-price market we have right now, and the reliance on efficiencies, and knowing what you're getting yourself into ahead of time, I'm sticking myself to Core Labs (CLB 0.43%).
Crowe: Jerk, you took mine.
Muckerman: Oh! Core Labs for the win!
Crowe: I'm going to have to pick another one.
Muckerman: You don't have to! It's your top stock! You can't say it's not your top stock anymore.
Crowe: I had a second-place one.
O'Reilly: Okay, so, technically, it's Core Labs squared.
Muckerman: And a bonus stock from Tyler.
Crowe: So, a bonus from me. We talked to these guys when we were down in Houston, giving people a little exclusive access on this one, DistributionNOW. They've been absolutely hammered just as much as everybody else.
O'Reilly: I can't wait to talk about them in a couple weeks on this show.
Crowe: Oh, I know.
O'Reilly: I learned a lot from those guys.
Crowe: One of those things that really stood out for me when they were talking, and one of the things that you talk about, if we were to start to see a modest recovery in prices that leads to some drilling activity, DistributionNOW is the first phone call from producers, because--
O'Reilly: Got to repair a rig that's been sitting there.
Crowe: --they're the ones with the spare parts, with everything the industry needs right then and there. And when the recovery happens, they'll be one of the first people to see the recovery, because--
Muckerman: --the phone starts ringing.
Crowe: Yeah. Producers aren't going to start getting better until they up their production with prices. So, they get it even before the producers get it. And if you're looking at something like that, on a 2016 rebound -- again, this is a guess -- my guess is, since they're such an early responder to drilling activity and oil prices, I think DistributionNOW could have a really good year.
Muckerman: You have to make the phone call before you start drilling.
Muckerman: It's true. Leading indicators.
O'Reilly: Perfect. I'm going to go with EOG just because I've been plugging it for the last six months--
Crowe: Ugh, boring.
O'Reilly: Oh, I'm sorry, Mr. Core Labs squared, am I boring you with my stock pick?
Muckerman: I like EOG, if you want to invest in a producer.
O'Reilly: They are a rock. They have held up super well.
Muckerman: They have held up, which might be the issue. They might have held up too well.
O'Reilly: How do you hold up too well?
Muckerman: In terms of their stock prices, because maybe people just wanted to remain in energy, and they flew to EOG--
Crowe: To remain conservative.
O'Reilly: A rock.
Muckerman: It's a rock, that's why stock prices are down as much as they are. Maybe they make an acquisition--
O'Reilly: "Like a rock."
Crowe: That was a really bad Bob Seger impression.
O'Reilly: I tried, I'm sorry.
Muckerman: You're good at most of them.
O'Reilly: I have never once claimed to be a good singer in my life.
Muckerman: Don't start today. Maybe that's--
O'Reilly: "Hey, who sings that? Maybe you should let him sing it." Alright, so, guys, happy New Year!
Crowe: You too.
Muckerman: You too.
O'Reilly: Do we have any champagne anywhere?
Muckerman: No, just tea.
O'Reilly: Tea? Lame. Oh well. That is it for us, folks. If you're a loyal listener and have questions or comments, we'd love to hear from you. Just email us at InustryFocus@fool.com. As always, people on this program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Tyler Crowe and Taylor Muckerman, happy New Year and Fool on!