With the first quarter coming to a close, it’s time once again to turn back the clock and take a look at the biggest stories affecting the energy sector. After all, you can’t know where you are going unless you learn from the past.
Overall, the energy sector — like most of the economy — was plagued by geopolitical events. The sequester in the U.S., issues in the Middle East and European debt woes continued to impact the many companies drilling, extracting and refining crude oil.
Still, the global economic situation seems to be strengthening, which in turn means rising demand and steady commodity pricing. That helped push shares prices for energy stocks to new highs in the first three months of 2013.
With that in mind, let’s take a look at three big trends in the sector from Q1, along with what to expect in the coming quarter.
One of the biggest trends energy investors faced during the first quarter was the increased amount of shareholder activism. Given the sector’s continued growth, many hedge funds, pensions and institutional investors targeted energy firms not “proving their mettle.”
These investors hope to improve their own — and smaller retail investors’ — positions by unlocking value at struggling firms. Many have pushed for master limited partnership (MLPs) spin-offs, special dividends, asset sales and complete board redesigns.
Already we saw billionaire Carl Icahn shove Chesapeake Energy (NYSE:CHK) CEO and founder Aubrey McClendon out the door … as well as push CVR Energy (NYSE:CVI) to unlock value via refining spin-off CVR Refining (NASDAQ:CVRR).
Likewise, hedge funds TPG-Axon and Mount Kellett Capital are hoping to emulate Icahn’s success by ousting Tom Ward from the top position at SandRidge Energy (NYSE:SD).
Perhaps the biggest activism story of all, though, has been at beleaguered integrated giant Hess (NYSE:HES). In the middle of its own transformation to become a pure E&P player, the firm was targeted by activist hedge fund Elliott Management — one of the its largest shareholders — to reshape the company.
Elliott accused the board of “poor oversight,” and said that the company’s management was responsible for more than a “decade of failures” that caused Hess’s stock price to flounder.
While the proxy fight at Hess is just beginning — and the company claimed its recent changes had nothing to do with Elliott’s criticisms — it highlights the fact that activism in the energy sector will be a pervasive trend for the foreseeable future.
Refining Stays Strong
The pricing dynamic between West Texas Intermediate (WTI) and Brent crude continued to be a boon for those firms that refine petroleum products. These downstream firms have been able to take advantage of lower-priced WTI crude oil, so crack spreads for refined products remain at highs (although that spread has dwindled over the last few weeks). And the wider the spread between crude oil and refined products, the more profitable refiners are.
For example, for both integrated majors Exxon (NYSE:XOM) and Chevron (NYSE:CVX), earnings made from refining and chemical operations drove their near-record profits. By using the cheaper feedstock, both Exxon and Chevron were able to increase margins at their downstream units.
Of course, it’s not just the majors that are benefiting from this trend.
The various independent refiners like Valero (NYSE:VLO) and Tesoro (NYSE:TSO) have entered a new renaissance as they have been able to take advantage of the pricing trend. That renaissance has helped push up share prices, boost cash flows and make the refiners dividend-paying machines.
While new pipelines, railroad tankers and crude terminals have reduced the huge spread in recent weeks, there still is a wide enough discount between the two oil benchmarks. More importantly, as unconventional drilling revolution continues to unlock a dearth of shale oil from regions like the Bakken or Eagle Ford, the refiners should be able generate big margins for years to come.
Closure in the Gulf
It’s been almost three years since BP’s (NYSE:BP) Deepwater Horizon disaster and the fallout from the worst oil spill in history may finally be coming to an end. The trial over liability for the disaster began Feb. 25 and will focus on determining whether one or more of the companies acted with willful or wanton misconduct or reckless indifference — the legal requirement for establishing gross negligence.
So far, BP has lost bids to remove it from the findings and could be shelling over more than $17.6 billion in damages. Likewise, contractor Halliburton (NYSE:HAL) and driller Transocean (NYSE:RIG) remain on the hook for damages.
But overall, the start of the trial at least represents a big step towards closer in the Gulf. And on the other side, production volumes continue to rise as the drilling moratorium enacted after the spill has been lifted. Big finds from firms such as Chevron and Anadarko (NYSE:APC) are breathing new life into the aging Gulf.
For investors, many of the trends that began in the first quarter — and the fourth quarter of 2012 — should continue into the next one. Rising activism and M&A activity will only increase as the energy sector strengthens and larger investors target weaker producers.
At the same time, much of that strength will come from unconventional sources in the ocean’s deep and North America’s shale formations. Onshore regions like the Marcellus and Eaglebine will continue to be game changers for the industry, while the deepwater in the Gulf will continue to transform the “dead sea.”
Finally, any return to sense of normalcy in the global economy will boost demand and prices for all varieties of energy commodities. That will benefit firms all across the energy spectrum — from the smallest wildcatter to the largest integrated giant.
All in all, the upcoming second quarter promises to be a doozy for investors in the energy sector — much like the first one.
As of this writing, Aaron Levitt did not own a position in any of the aforementioned securities.