Tag Archives: energy

Summary With Crude Oil Prices in mid $40s, up from high $30s, a turn may be coming for independent new extraction technology explorers and producers. Tough times of world price cuts by more than 60% leave only the strongly resourced, well-financed, advantaged survivors. Their rebound time may be near at hand, as seen in large-volume order flows from big-$ investment portfolio managers. Who are the best positioned energy stock survivors? The best candidates are indicated by the “order flow” from big-money “institutional” clients of market-making investment banks, suggesting high-probability additions to their billion-dollar portfolios. (If you have read this story before, please skip directly to Figures 1 and 2) The fund-management clients have extensive, experienced research staffs constantly looking for sound, long-term, rewarding investment candidates. The presence of their interest in these issues typically is a disruptive influence to markets because of their size of transaction orders. The “regular way” every-day “retail” investment transactions largely get handled (or mis-handled) by automated systems developed by advances in transaction technology. Those advances have cut the costs for individual investors to fractions of a cent per share, compared to pre-Y2K costs of sometimes a dollar or more a share. But big-volume “block” orders can’t be handled that way without crashing the system. They must be negotiated among other big players in this very serious game. That is where the market-maker firms play an important role. The MM firms know which players own what, and have a good idea of what their current appetites may be. Usually differences of opinion as to appropriate valuations for specific stocks are not evenly balanced enough among these fund-manager players to instantly “cross” trades of tens or hundreds of thousand shares. So the MM firms even out the balance between buyers and sellers by temporarily committing their own capital. But they don’t go naked. The at-risk commitments of MMs are always hedged in one way or another, and the cost of that protection is borne by the trade-originating client. It is built into the trade “spread” between the single per-share price of the block deal and the current “regular-way” market price. The cost of the hedge deal and the structure it takes is negotiated between the arbitrage artists of the MM firms block trade desks and “Prop” trade desks in open competitive combat. What it costs and the shape it takes reveals what these well-informed, profiting antagonists believe is possible to occur between now and the time it may take to unwind the contracts on derivatives used in the hedge. That often could be as much as a few months. So the range of possible prices implied is not an instantaneous, trivial spread. Often it is 10% to 20% or more, given the uncertainties involved in the underlying security. Where today’s market quote lies in that forecast range may be important in the stock’s future movement. The first thing to remember about this analysis is that it is a “snapshot” of current conditions, dominated by price relationships that are likely to change in coming days, weeks, and months. Those changes are typically the main point on most player scorecards. This article is not an evaluation of how “good” the companies involved are at managing, competing, profiting, or treating their employees or shareholders. It simply tells how well on this date the perceived prospects for each equity investment security candidate may be, compared with those of others, on a variety of matters and measures of concern. This is not a long-term hold evaluation. But it could identify overlooked, near-term value opportunities to be captured by active investing management. The place to start in the analysis is with the market character presented by each of the best dozens of stocks out of the hundred or more once on the scene. Figure 1 tells those stories: Figure 1 (click to enlarge) Source: Yahoo Finance, Peter Way Associates Items of concern here have to do with how easy it may be to get out of a position if in a hurry, and what the cost of doing so might entail. The first four columns do so by calculating how many market days’ average volume of trading at the current price it would take to completely replace existing shareholders. That is not expected to happen, it just gives a realistic comparative measure of how easy or difficult it might be to extricate oneself from an unwanted position. Extreme examples here are Enbridge (NYSE: ENB ), with a million-share-a-day trading volume to take over 3 years to clear its huge $34 billion of outstanding shares. At the other extreme is the market-tracking SPDR S&P 500 Index ETF (NYSEARCA: SPY ) with a five times as large ownership value, but 139 million share daily volume doing the task every 6 days. Yes, Sasol, Ltd.(NYSE: SSL ) shows a capital turn in over a thousand days, but it is a South African company and its principal share trading takes place in markets outside of the US. Another dimension of the distress of departure is what the typical trade cost may be, which can be indicated by the stock’s bid-offer spread. These days that tends to be a tiny fraction of the value per share during normal market hours. But every investor needs to protect themselves against errant or intentional malicious spread quotes by always using price limit orders when changing positions, instead of unrestrained “at market” orders. The other useful matter of perspective in Figure 1 is a sense of each stock’s current price in relation to its past year’s trading range, and a sense of how the size of that range compares to alternative investments. The Range Index [RI] tells what proportion of the whole range lies below the stock’s current price. A low past RI indicates a price depressed in comparison with earlier trading, and a high past RI tells of a stock that has been on the move up near new highs. The range size is a dimension only discussed in the media as an example of either triumph or disaster, but rarely in company of comparable alternatives. The average sizes here in this group are over 100%, meaning that a double in price (or a 50% drop) is commonplace. The latter phase just mentioned of that change scares most investors, as it should. But it is an all-too-common condition, often setting the stage for the former-mentioned next joy. So what does come next? That is what everyone wants to know, and not knowing for sure, everyone guesses at. MMs have a leg up in the game, since they know what their clients, with the money muscle to move markets, are trying to do. The well-informed protection sellers provide deals very likely to assure themselves of nice profits, with little likelihood of having to deliver on the immunization. A done deal tells where the extreme possibilities lie. Those outer limits have been shown in a high proportion of instances to be quite reachable. The agile, fleet-of-foot protection sellers usually manage to profitably transfer the accepted risks to others and get on to the next deal before having to make good on their bet this time (again). So the price range forecasts implied by the capital-risk hedging can be useful information to others interested in the stocks or ETFs involved. To determine how useful the current forecasts may be, we look back to how similar prior forecasts (made without knowledge of what next happened) were actually treated by a merciless marketplace. Figure 2 tells the particulars, and provides a means of ranking the attractiveness for wealth-building active investors. Figure 2 (click to enlarge) source: Peter Way Associates, blockdesk.com At the outset, something about Figure 2 should be understood. Columns (2) and (3) are current-day forecasts, implied by the self-protective actions of market-making professionals in the course of serving transaction orders from big-$ clients at or near column (4). All the remaining columns are matters of record of how prior forecasts for the subjects in column (1), made live in real-time over the past 5 years, have actually performed. Those prior forecasts were only those of the total available in (12) that had upside-to-downside proportions like the current forecast, described in (7). The Range Index [RI] tells what percentage of the whole forecast range lies below (4). The size of this sample set of forecasts has potential statistical implications if it is small. Few of the subjects of Figure 2 have that problem, and none of the top ten. This is the importance of column (12), a dimension pertinent to all references to prior performance. The number of forecasts available in any subject’s current situation is a function of the current Range Index. More will be available when the RI is in the 30-50 area and fewer when the subject is at extremes, nearing zero or 100. Market price behavior varies from subject to subject for a variety of reasons, so attractiveness based solely on RI can be misleading. That makes this kind of analysis in detail important. Additional evaluations may be useful when RIs are at or near extremes. The historical data of Figure 2 differs significantly from “back-test” data because it is based on the live forecasts made at the time, when subsequent price action confirmations were not available. The usual back-test data only is presented when full knowledge of the outcomes is at hand. That makes it impossible to know what kind of decisions might have been made at the time. This historical data applies our standard TERMD portfolio management discipline to buy positions of all column (12) sample forecasts. TERMD has been in existence for over a decade. It is more fully described below . For example, column (6) is an average of the worst-case price drawdowns from the closing price of the subject on the next market day after the forecast, over the holding period up to the position’s closing. This is the relevant measure of risk, since it identifies the greatest loss likely to be taken at the point of maximum emotional stress. Column (8) on the other hand, tells what proportion of the sample forecasts were able to recover from the (6) experience and be closed out profitably by reaching (5) sell targets or by TERMD’s holding period time limit of 3 months. Column (5) relates (2) to (4). Column (9) tells what the closeouts of all subject sample forecast positions averaged, profits, net of losses (by geometric mean). The CAGR of these experiences in (11) uses the average holding period of (10) in conjunction with (9). The promise of (5) is tested by (9) in (13). The proportion of (5) to (6) is shown in (14). Overall, a figure-of-merit is calculated in (15) by odds-weighting (5) by (8) and (6) by (8)’s complement, further conditioned by the frequency of (12). The table’s contents are ranked by (15). That ranking is what ordered Figure 1. What it all suggests Without getting into a detailed discussion of the attributes of interest, comparisons of the best-odds (most attractive by column 15) ten E&P stocks with a market-average tracking alternative ETF, SPY, show upside price changes (5) almost twice as large, and risk exposures (6) about one and a half times as large. Their forecast history translates into CAGR performances (11) four times as good as market results, with odds for profit outcomes (8) about the same, 8 out of every 10. But comparisons with the best 20 propositions from the measurable overall equity population of 2711 alternatives, puts the Oil&Gas E&P stocks at a disadvantage. The difference lies not in the size of the payoff promise, but in its follow-through. The average price gains of the population’s best stocks surpassed their forecasts +11.4% to +10.4% , with 9 out of every 10 experiences profitable, and average holding periods to reach payoffs shorter by 36 market days to 41, or roughly 7 weeks compared to 8. That leads to a CAGR past result (11) of 114%, double the comparable measure of +55% for the E&Ps. Conclusion I appears that there is sufficient early action in volume trade transactions in Oil & Gas independent Explorers and Producers to elevate expectations for their coming stock prices to a level more than competitive with passive market-index ETF investing. Best candidates may be PDC Energy (NASDAQ: PDCE ) and Matador Resources (NYSE: MTDR ). Perhaps in coming weeks this activity will strengthen and raise the prospects higher. But at present there are a number of alternative equity investments that substantially surpass the typical prospects of the best of this group. Commitments among those alternatives should be better rewarded. Patience, my energy friends. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.