Energy market commentary: December 2018

Data as of December 31, 2018 unless otherwise noted

Performance (total returns)

Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.

Oil prices continue to fall; energy markets end a rocky year: WTI crude prices ended a volatile year at $45.44/bbl, about $15 below where they started. As recently as early October, prices were above $75/bbl, but a host of factors contributed to the largest quarterly price decline since 2014.¹ On the supply side, fears of a glut were exacerbated by building U.S. crude stockpiles, which have risen 47 million barrels since mid-September, and increasing Russian production.¹ On the demand side, trade tensions and unimpressive global economic data stoked concerns. Energy equities fell alongside the rest of the stock market, which saw its worst December since 1931. Within energy, large-cap energy stocks were the top decliner on the month, while midstream indices each decreased around 9%. HY Energy sold off nearly 4% as spreads widened nearly 150 bps and the broader high yield bond market continued to see significant outflows.¹ Looking to 2019, the market will be watching to see how effective OPEC’s agreed-upon production cuts are at stemming potential global oversupply concerns.

Year-end review: Is now a good time to allocate to energy?: A promising year for energy investors gave way to a reversal in the fourth quarter, as oil prices plummeted and global financial markets fell into bear-market territory. Midstream indices finished down less than S&P Energy, but the AMZX and AMEIX still declined by 12.42% and 17.67%, respectively, in 2018. The question that will be asked is whether this represents a buying opportunity, or if the recent dip portends further losses for the space. We believe three factors point to a potential buying opportunity: macro fundamentals, company financial performance and valuations. While oil price fundamentals have taken a negative turn, the midstream backdrop remains solid. The EIA expects U.S. production to continue to increase, which will necessitate further capital investment opportunities for infrastructure firms.¹ We believe this will further support midstream financial performance, where over half of constituents in the two Alerian indices beat median EBITDA expectations in both Q2 and Q3 2018.² Despite this strong performance, valuations are at multi-year lows. The P/E ratio of the AMEIX is currently 16.24, the lowest on record, while the P/E of the AMZX is 13.77, the lowest quarterly mark since 2009.³ Additionally, the spread to 10-year Treasury yield for each index ended the year approximately 150 bps wider than their respective 5-year average.⁴ To conclude, we believe that a solid backdrop will help continue to drive positive company performance, and that historically low valuations may present an attractive entry point for investors heading into 2019.

Key takeaways

• Energy markets declined sharply as oil prices fell and equity markets sold off.
• Crude oil fell another $5.26/bbl amid continuing concerns of a supply glut.
• The recent energy sell-off has pushed midstream valuations to multi-year lows.