Raymond James Energy Stat of the Week
by J. Marshall Adkins

Energy Stat: Is the Recent Selloff in Permian-Exposed Energy Stocks Warranted?
June 18, 2018

We've written extensively about the widening regional Permian oil price differentials that have been driving Permian and WTI prices lower relative to Brent oil prices. To rehash: the disconnect is due to the Permian basin's pipeline takeaway constraints that are now starting to back U.S. crude up through the middle of the country, driving Brent-WTI differentials and other mid-continent basin differentials wider. As we have noted in recent pieces, we are now modeling this problem to persist over the next 12 to 18 months. Here are the numbers: As of mid-June, Midland's discount versus WTI has widened out to nearly $8.50/Bbl, over and above WTI's discount versus Brent of about $8.50/Bbl leading Midland prices to be a whopping $17/bbl LOWER than Brent oil prices.

More importantly, we believe the WTI to Brent spread will gradually widen in 2018 to a full $15/bbl driving the Midland to Brent discount to $25/bbl. While we are conservatively modeling this extremely wide Permian to Brent spread to remain in place through the end of 2019 (when additional pipes alleviate the bottleneck), we suspect the market will react to these extreme prices (through rail, trucking, DUC builds, etc.) and eventually drive the spread lower in 2019.

Either way, the perceived impact of lower Permian spot prices upon the industry has led to significant relative underperformance among Permian-exposed energy stocks (both E&P and oilservice) over the past month. As shown in the two charts below, energy stocks that are generally considered to be more exposed to the Permian have materially underperformed their non-Permian peers year-to-date. Specifically, a basket of E&Ps with Permian assets has underperformed by around 18%; while a basket of oil service names with Permian operations has underperformed by around 22%. Investors are clearly spooked by the prospect of seriously impacted E&P cash flows and resulting slowdown in oilfield activity. In today's stat, we will try to explain 1) why the selloff in the Permian related stocks is now way overdone despite the Permian oil pricing headwinds; 2) outline which E&Ps are best and worst positioned to weather these headwinds; 3) quantify why Permian pricing is less impactful for industrywide E&P cash flows and drilling activity than many think; and 4) extend our analysis beyond the Permian to the broader issue of the Brent-WTI pricing relationship.

This is a summary of a much more detailed commentary. Please contact your financial advisor for the full report.

There is no assurance any of the trends mentioned will continue in the future. Past performance is not indicative of future results. Investing involves risk and investors may incur a profit or a loss. Specific sector investing can be subject to different and greater risks than more diversified investments. Investing in commodities is generally considered speculative because of the significant potential for investment loss. Commodities are volatile investments and should only form a small part of a diversified portfolio. Markets for commodities are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

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