There is never a dull day in the energy sector, as shares of oil E&P’s and oil service companies tend to make big moves one way or the other. In Monday’s case, shares of Baytex Energy Corp (USA) (NYSE:BTE), Penn West Petroleum Ltd (USA) (NYSE:PWE), EP Energy Corp (NYSE:EPE), and Seadrill Ltd (NYSE:SDRL), among others, are moving notably lower. Let’s take a closer look at the downside catalyst and see if the smart money disagrees with the market on any of them.
Most investors don’t understand hedge funds and indicators that are based on hedge funds’ activities. They ignore hedge funds because of their recent poor performance in the bull market. Our research indicates that hedge funds underperformed because they aren’t 100% long. Hedge fund fees are also very large compared to the returns generated and they reduce the net returns experienced by investors. We uncovered that hedge funds’ long positions actually outperformed the market. For instance the 15 most popular small-cap stocks among funds beat the S&P 500 Index by more than 53 percentage points since the end of August 2012. These stocks returned a cumulative of 102% vs. a 49% gain for the S&P 500 Index (see the details here). That’s why we believe investors should pay attention to what hedge funds are buying (rather than what their net returns are).
Shares of Baytex Energy Corp (USA) (NYSE:BTE), Penn West Petroleum Ltd (USA) (NYSE:PWE), EP Energy Corp (NYSE:EPE), and Seadrill Ltd (NYSE:SDRL) are down because Brent is off by 2.8% and WTI is down by 2.2% in afternoon trading. Given the debt on their balance sheets, all four securities are high beta, so a sharp move in crude will likely mean an even sharper move in the stock prices of the four companies.
All four companies’ fortunes will improve substantially if crude rallies to a high enough point, although given the current oversupply situation in the industry, investors are uncertain when crude will recover, with not expected in the near-term. At current prices, most high beta energy companies are not profitable and have finite timelines to wait for crude to recover. Some companies, such as Seadrill, can afford to wait longer for crude to recover than others, however.
Crude prices have halved since August of last year because of weak macro economic factors and Saudi Arabia increasing its production by one million barrels a day. The combination has created a serious supply glut that has pushed inventories to record levels. Crude speculators are likely selling off crude futures today because they are concerned about near-term oversupply. The prospect of Saudi Arabia working with Russia to correct oversupply has also diminished after Russia began bombing various parties in Syria (of which Saudi Arabia likely supports).
Still, there have been some recent green shoots, and crude can’t stay low forever. There are signs that non-OPEC production is decreasing and crude demand is increasing. The attractiveness of the four securities depends on the timing of the crude rebound. The faster crude rebounds, the better for the four companies.
On the next page, we’ll analyze hedge fund sentiment toward the four companies.