oil


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U.S. oil and natural gas is on the verge of transforming the world’s energy markets for a second time, further undercutting Saudi Arabia and Russia.

The widespread adoption of fracking in the U.S. opened billions of barrels of oil and trillions of cubic feet of natural gas to production and transformed the global energy sector in a matter of a few years. Now, a leading global energy agency says U.S. natural gas is about to do it again.

The International Energy Agency (IEA) said in a new forecast this week that growth in U.S. oil production will cover 80% of new global demand for oil in the next three years. U.S. oil production is expected to increase nearly 30% to 17 million barrels a day by 2023 with much of that growth coming from oil produced through fracking in West Texas.

“Non-OPEC supply growth is very, very strong, which will change a lot of parameters of the oil market in the next years to come,” Fatih Birol, the head of the International Energy Agency, told reporters at the CERAWeek energy conference hosted by IHS Markit. “We are going to see a major second wave of U.S. shale production coming.”

Republicans politicians and policymakers celebrated the news and sought to take credit for the development. Trump has sought to portray himself as a savior of the U.S. oil and gas industryopening up federal lands to oil and gas development at a breakneck pace and undoing Obama-era climate regulations.

But analysts attributed the growth in U.S. production to market factors rather than Republican policy. In the report, the IEA forecast that higher oil prices and increased demand from China and India will trigger increased U.S. output to make up the gap. The IEA also predicts that demand for petrochemicals used in plastic will grow overall demand for oil.

Still, the White House sent out a press release highlighting the report on Monday. Republican Sen. Dan Sullivan of Alaska told reporters at CERAWeek that Republican dominated Washington has transformed the federal government from being “basically hostile” to oil and gas under President Obama to actively supporting the industry’s growth. (In reality, Obama promoted natural gas as part of an “all of the above” energy strategy and his signature climate change regulation would have benefited the fossil fuel.)

“There’s never been a more exciting time in the American energy sector,” Sullivan told oil and gas industry insiders. “The American energy renaissance that so many of you in this room are responsible for is now in full swing.”

A second rise in U.S. oil production comes with significant implications for both the global energy markets and geopolitics more broadly. The U.S. supply of oil and natural gas has contributed to political upheaval in the Middle East, creating new competition for oil exports, and in Russia, a leading supplier of natural gas to Europe.

Alexei Texler, Russia’s first deputy energy minister, acknowledged that U.S. shale “poses certain risk” Tuesday but said his country would continue collaborating with partners in Saudi Arabia and elsewhere in response.

“In a shale revolution world, no country is an island,” said Birol. “Everyone will be affected.”

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Investors interested in dividend income should take a closer look at high-quality, high yield MLPs like Magellan Midstream PartnersEnterprise Products Partners and Buckeye Partners.

These three high-yield MLPs have dividend yields ranging from 5% to 7%. Plus, their fundamentals have remained healthy during the current downturn, which means their dividends are sustainable, even at $50 oil.

These MLPs have all increased their dividends for more than 10 years in a row. These years include the Great Recession of 2007-2008, as well as the current downturn.

Investors might be reluctant to buy MLPs, and who could argue? Many were ravaged when oil and gas prices fell from 2014 to 2016. However, the hardest-hit MLPs were in the upstream segment, which refers to exploration and production.

Magellan, Enterprise Products and Buckeye are all midstream MLPs. This means they operate oil and gas storage and transportation assets, such as pipelines and terminals.

Midstream companies operate more like toll roads; they collect fees based on volumes. Therefore, most of their revenues are not based on commodity prices. These three high-yield MLPs are able to cover their hefty distributions.

Magellan has a 5% current yield, while Enterprise Products and Buckeye Partners yield 6% and 7.7%, respectively.

Not only do all three MLPs have high dividend yields, but they raise their distributions on an annual basis. Their consistent dividend growth is thanks to their high cash flow.

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Pipeline and energy infrastructure companies face operational challenges in the coming years even as U.S. oil drilling recovers and a natural gas export boom gets underway, consulting firm Bain & Co. says in a new report.

While there is demand for new infrastructure, three trends in the industry could trip up pipeline companies, Bain said in a report released Wednesday. Oil and gas drilling is subdued in some areas, contract renewals may lead to lower rates, and private equity competition is eating into profit margins.

This will make it harder for so-called midstream companies, which transport, store and process oil and gas, to squeeze profit out of their projects, according to Bain.

This matters to investors because investing in midstream companies became a source of reliable dividends as pipeline construction ramped up during the U.S. shale oil and gas boom. Pipelines and other infrastructure produce steady income, allowing midstream companies to ratchet up payouts to investors.

The 10-year average annual distribution growth for master limited partnerships, a common structure for energy infrastructure companies, was 6.8 percent through 2015, according to Alerian, which operates funds linked to MLPs.

“There’s a starvation for yield right now because the 10-year [U.S. Treasury] is barely over 2 [percent]. Utility and REIT yields are really, really low. You can go buy energy infrastructure stocks that have 5.5, 6.5 percent yields that are growing,” Rob Thummel, portfolio manager at Tortoise Capital, told CNBC’s “Power Lunch” on Tuesday.

Stranded assets

Oil and gas from some regions that would have moved through pipes are now stranded in the ground because they’re too expensive to extract, pipeline executives told Bain.

Some low-cost regions like Texas’ Permian basin have rebounded quickly. But sharp production declines in other basins, like North Dakota’s Bakken, have not yet reversed significantly. The focus on sweet spots could reduce production in places like the Rockies, lowering the need for pipelines and other infrastructure.

Portfolio managers say they’re keenly focused on this issue.

“It’s kind of like real estate. It’s all about location, location, location when investing in some of these MLPs,” Thummel told CNBC in a separate interview Wednesday.

“The way we mitigate that is making sure our companies have diversified assets. You’ve got to be careful investing in just concentrated positions in concentrated areas,” he added.

Two of Thummel’s top diversified picks are Enterprise Products Partners (NYSE: EPD)and EQT Midstream Partners (NYSE: EQM), which yield 6.7 percent and 5.1 percent, respectively.

Tougher contracts

Another worry that Bain flags is the coming expiration of favorable contracts that pipeline companies signed with their customers during a construction boom. Contract provisions that guaranteed a minimum payment no matter how much product flowed through their lines have protected their revenue.

Pipeline operators will likely have to agree to lower volumes and rates when they negotiate new contracts, Bain says. That’s a problem, especially for companies that pipe oil and gas out of basins where production is falling, according to Bain.

While this midstream sector hasn’t entirely resolved this issue, concerns about contracts have already been priced into midstream stocks and MLP units, said Jay Hatfield, a portfolio manager for InfraCap’s AMZA exchange-traded fund (NYSE Arca: AMZA), which tracks midstream companies.

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MLPs combine the tax benefits of partnerships—profits are taxed only when investors receive them as distributions—with the daily trading of stocks. Many own energy assets like pipelines and refineries and collect toll-like fees that rise with inflation. That can leave them better positioned than bonds, with their fixed coupon payments, if inflation picks up and interest rates rise.

Over the two years through June 2006, when the target federal-funds rate rose from 1% to 5.25%, MLPs returned 38.7%, helped by rising distributions, according to Alerian, which publishes MLP indexes used for exchange-traded funds.

MLPs have downsides. They generate K-1 statements, which can add a step or two for investors who prepare their own tax returns. They’re often not appropriate for retirement accounts. And although MLPs aren’t as tied to swings in crude oil prices as, say, oil drillers, they can still suffer sharp downturns.

The Alerian MLP index fell by more than half—from a peak of over 530 to a trough of about 250—during a crude oil swoon that started in mid-2014 and ran through early 2016. Today, the index is not far off its low, at a recent 289.

MLP downturns have historically been compounded by the way the group funds new projects. Historically, MLP operators have paid out the bulk of profits as distributions, and financed projects by issuing shares or taking on debt. During the recent collapse, many MLPs, not wanting to issue shares at low prices or raise their leverage, cut back on distributions in order to become more self-sufficient on funding.

Soon, says Osterweis, MLPs will have built up a cash cushion for project financing and will go back to raising their payouts. For investors who wonder whether to lock in bonds before prices rebound and yields drop again, MLPs can offer diversification and the prospect of rising payments.

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So there’s a tension here. Saudi Arabia is supposed to be the world’s swing producer and they have finally acceded to output cuts to stabilize oil prices, getting Russia onboard too. But, at today’s prices, a lot of North American shale production is viable and these guys are swamping the market, with rig counts up every week.

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Now, if you look at the North American rig count numbers in a multi-year context things, we are nowhere near the highs of 2014.

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But back in March, I was calling the rig count a bubble. And the longest term view makes clear why.

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So, while one could legitimately call the increase in rig count and the switch of oil majors to shale oil investment an echo bubble, the size of the uptick is nowhere near what we saw before. And given where oil prices are coming from – $50 a barrel, there is no support for the kind of capex we saw when oil traded above $100 a barrel.

Why this matters. Oil prices are not going up dramatically. Shale oil has become the swing producer, and these shale projects are viable at these levels, ensuring a supply glut which will keep prices under pressure. But the downdraft in capex from any collapse in prices is likely to be more muted and have less impact on the economy. At the same time, with global growth re-accelerating, the fall in prices could be a windfall for consumers, especially in developed economies where workers’ real earnings is still recovering.

On net, I believe the scenario is negative for global growth, if marginally so. The risk is in credit, particularly regarding knock-on effects for emerging markets, commodity credits and high yield more generally.

The Fed is only likely to pause if we get a panic situation that drags oil back down to $30 a barrel. But, while the Fed is on course for three or four rate hikes this year because of a tightening bias, oil in the $40 range will get the Fed’s attention because of the capex and consumption implications.

Bottom line: oil prices will continue to be under pressure as long as rig counts are rising. We will see a yo-yoing of prices, but the calls for $60 or $70 a barrel look misplaced. Analysts still expect WTI to average $55 for the whole of 2017; these forecasts will be under pressure. Yield curve flattening and pressure on emerging market and high yield credits are the biggest risks.

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Looking at oil. Sentiment has pretty much run its course on oil. The previous article was a good example of this.

That being said, the world demand for oil isn’t going to disappear anytime soon. Therefore holding oil for a period of time is not going to be overly risky. Yes, there is an increased supply, which will keep prices lower, but we simply need some fluctuation, not necessarily a strong bull market.

The quite long period of consolidation should give us a reasonably low risk entry point. The $7 – $9 range is a 28% fluctuation range, enough to trade consistently.

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Oil hasn’t been at the forefront of market discussion for a little while now. It may be soon. Oil is falling once again.

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With it, now, are the energy stocks who’s fortunes are tied to the oil price. Oil supply is plentiful and no-one on the producer side seems willing to cut or halt production. Therefore, you would expect further pressure on the price of oil.

Will the overall market follow oil and oil stocks lower?

Who really knows. But the overall market as measured by SPY, DIA, QQQ, hasn’t really moved anywhere in the last month or so. Earnings reports that beat, go nowhere.

Cheaper oil for me is great if it brings down petrol prices, and good for manufacturers/producers that use oil somewhere in their product.

But the overall market just doesn’t seem to like lower oil prices. If oil continues lower to retest the previous lows, the overall market may just follow again.

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