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Rising Oil Prices Make Energy Bonds An Attractive Play

Category: Energy & Environment,Finance

It may be disappointing to financial market pundits, but oil futures prices have shown very little volatility of late.  The CBOE’s measure of oil futures’ volatility--often called the oil VIX-- has fallen below 25, a level that has historically provided support.  

It is difficult to see dark clouds on the horizon for crude prices, though, given the balance that exists between supply and demand in the global oil markets at the present time.  This is a dynamic I have highlighted in my Forbes columns in recent months.  The Energy Information Administration’s release of its Weekly Petroleum Status report this morning caused nary a gyration in energy prices, as the 7.0 million barrel build in U.S. crude oil inventories was offset by a 7.7 million barrel decline in inventories of gasoline and the front-month crude futures contract is quoted at $64.55/barrel as of this writing.

I am feeling pretty good about my call for a gently-sloping upward move in oil prices in 2019, but as an active asset manager there is still the thorny problem of profiting from such a move.  The SPDR energy sector ETF, XLE, has had a nice move thus far in 2019, posting a 17.56% gain versus the S&P 500's 15.01% gain, but still sits below its level of April 10, 2018.

An image of working oil field pump jacks in winter.

Getty

Of course, the stock market is not the only game in town.  Investors need to realize that higher crude prices mean higher cash flows for oil and gas companies, especially exploration and production companies (E&Ps.)  It's an old cliche, but “it drops straight to the bottom line” is a very accurate description of the phenomenon that occurs for E&Ps when oil prices rise for a sustained period. This is especially true for those companies managed by teams wise enough not to gamble on the futures markets via hedging.

So, the opportunity exists for savvy investors to play the fear that exists in the credit market of “volatile energy pricing” when, in fact, energy prices haven’t been volatile at all of late.  The numbers back that up, as well.  S&P’s High Yield Energy Corporate Bond Index has been a terrific performer of late, posting an 8.33% gain through the end of March and posting a three-year annualized performance of 13.48% to that date.  That three-year performance compares to the paltry annualized return of 3.36% from the broader S&P 500 Bond Index. The High Yield Energy Corporate Bond Index has also obliterated the performance of energy stocks for the past three years--13.48% versus 5.60% for XLE--and even compares favorably to the benchmark equity index S&P 500’s 14.32% annualized performance for the past three years.  

Picking individual bonds involves more work than picking individual stocks, as bonds have CUSIPs instead of ticker symbols and bond prices are not as widely quoted as stock prices.  Finra’s market data site, operated by Morningstar, is a terrific resource and I use it daily.  Also, for investors who require investments to contain a ticker symbol and are also willing to slide one rung down on the corporate capital structure, many E&P companies have publicly traded preferred stocks as well as bonds.  

The table below lists a few of my favorite names among E&P fixed-income securities.  They should be part of your portfolio, too.  My firm owns all securities listed.

 Company  Security Coupon (%) Maturity  Price ($)  Yield (%)
Callon Petroleum CPE4640205 6.375 7/2026 101.25 6.089
PDC Energy PETD4650889 5.750 5/2026 98.752 5.967
Denbury Resources DNR4667227  7.500  7/2024  88.75  10.519
 Callon Petroleum  CPE-A  10.000  perpetual  50.53 9.900
 Matador Resources MTDR4770388  5.875  9/2026  99.867  5.896

 

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It may be disappointing to financial market pundits, but oil futures prices have shown very little volatility of late.  The CBOE’s measure of oil futures’ volatility--often called the oil VIX-- has fallen below 25, a level that has historically provided support.  

It is difficult to see dark clouds on the horizon for crude prices, though, given the balance that exists between supply and demand in the global oil markets at the present time.  This is a dynamic I have highlighted in my Forbes columns in recent months.  The Energy Information Administration’s release of its Weekly Petroleum Status report this morning caused nary a gyration in energy prices, as the 7.0 million barrel build in U.S. crude oil inventories was offset by a 7.7 million barrel decline in inventories of gasoline and the front-month crude futures contract is quoted at $64.55/barrel as of this writing.

I am feeling pretty good about my call for a gently-sloping upward move in oil prices in 2019, but as an active asset manager there is still the thorny problem of profiting from such a move.  The SPDR energy sector ETF, XLE, has had a nice move thus far in 2019, posting a 17.56% gain versus the S&P 500's 15.01% gain, but still sits below its level of April 10, 2018.

An image of working oil field pump jacks in winter.

Getty

Of course, the stock market is not the only game in town.  Investors need to realize that higher crude prices mean higher cash flows for oil and gas companies, especially exploration and production companies (E&Ps.)  It's an old cliche, but “it drops straight to the bottom line” is a very accurate description of the phenomenon that occurs for E&Ps when oil prices rise for a sustained period. This is especially true for those companies managed by teams wise enough not to gamble on the futures markets via hedging.

So, the opportunity exists for savvy investors to play the fear that exists in the credit market of “volatile energy pricing” when, in fact, energy prices haven’t been volatile at all of late.  The numbers back that up, as well.  S&P’s High Yield Energy Corporate Bond Index has been a terrific performer of late, posting an 8.33% gain through the end of March and posting a three-year annualized performance of 13.48% to that date.  That three-year performance compares to the paltry annualized return of 3.36% from the broader S&P 500 Bond Index. The High Yield Energy Corporate Bond Index has also obliterated the performance of energy stocks for the past three years--13.48% versus 5.60% for XLE--and even compares favorably to the benchmark equity index S&P 500’s 14.32% annualized performance for the past three years.  

Picking individual bonds involves more work than picking individual stocks, as bonds have CUSIPs instead of ticker symbols and bond prices are not as widely quoted as stock prices.  Finra’s market data site, operated by Morningstar, is a terrific resource and I use it daily.  Also, for investors who require investments to contain a ticker symbol and are also willing to slide one rung down on the corporate capital structure, many E&P companies have publicly traded preferred stocks as well as bonds.  

The table below lists a few of my favorite names among E&P fixed-income securities.  They should be part of your portfolio, too.  My firm owns all securities listed.

 Company  Security Coupon (%) Maturity  Price ($)  Yield (%)
Callon Petroleum CPE4640205 6.375 7/2026 101.25 6.089
PDC Energy PETD4650889 5.750 5/2026 98.752 5.967
Denbury Resources DNR4667227  7.500  7/2024  88.75  10.519
 Callon Petroleum  CPE-A  10.000  perpetual  50.53 9.900
 Matador Resources MTDR4770388  5.875  9/2026  99.867  5.896

 


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