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Energy Q4 Earnings Season on Tap: What Could be in Store?

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Halliburton (HAL - Free Report) kicks off Oils-Energy earnings season with its fourth-quarter results today. Kinder Morgan (KMI - Free Report) and Schlumberger (SLB - Free Report) will report later in the week.

Despite vaccine progress and a rebound in macro conditions, commodity prices and demand are yet to reach year-ago (or pre-pandemic) levels. This is likely to have played foul on the sector’s top and bottom lines with negative year-over-year growth expected on both fronts. While the returns improved in the third quarter on gradually tightening fundamentals, the October-December period should further reinforce the sector’s stability going forward. Amid expectations of fuel demand coming back, investors will also be looking for more constructive signs of recovery to start the year 2021.

Over the next month or so, as we make our way through the earnings deluge, here are the important things to look for:

Revenue & Earnings Comparison Relative to Q4 '19

According to the U.S. Energy Information Administration, in October, November and December of 2019, the average monthly WTI crude price was $53.96, $57.03 and $59.88 per barrel, respectively. In 2020, average prices were much lower — $39.40 in October, $40.94 in November and $47.02 in December.

However, the news is a little better on the natural gas front. In Q4 of 2019, U.S. Henry Hub average natural gas prices were $2.33 per MMBtu in October and rose to $2.65 in November before tumbling to $2.22 in December. Coming to 2020, the fuel was trading at $2.39, $2.61 and $2.59 per MMBtu, in October, November and December, respectively. In other words, natural gas traded higher in two of the three months.

Taking into account the sharp drop in oil price in particular, which forms the bulk of most companies’ production, the picture looks rather downbeat for the Q4 earnings season. Per the latest Earnings Trends, Energy is likely to have experienced big earnings decline from a year earlier. Per our expectations, the sector’s earnings are likely to have slumped 92.9% from fourth-quarter 2019 on 31.5% lower revenues.

How Will the Sub-Industries Perform?

From upstream (exploration and production) to midstream (pipelines) to downstream (refining and distribution), no subset of energy has been immune to the coronavirus-induced downturn.

While the price slump will greatly impact the results of E&P companies for obvious reasons, the refiners’ numbers will be dragged down by weakness in the usage of jet fuel and gasoline with air travel severely hampered by the virus resurgence and its related restrictions. This demand softness will impact crack spreads (or refining margins) and offset the slight improvement in utilization.

Meanwhile, the trough in prices and demand has pushed drilling activity lower. This will automatically translate into lesser work for the oilfield service firms — companies that make it possible for upstream players to drill for oil and gas. Agreed, rig count has recovered considerably, costs have been slashed and completion activity is looking up too but overcapacity and pricing pressure would restrict the positive impact.

Finally, with E&P operators pulling back activities and curtailing production in response to sharply lower commodity pricing and demand, the pipeline companies are faced with a declining-to-flat volume through their facilities, contributing to expectations for depressed profits. Despite having a lower correlation to oil and gas prices compared to its other energy peers, the energy infrastructure providers have struggled with the implications of lower commodity realizations and demand destruction. 

What’s the Outlook for Dividends/Distributions?

A number of energy companies — including some of the world’s biggest — announced coronavirus-related dividend cuts during the coronavirus-ravaged 2020. Schlumberger lowered its payout by 75%, while Royal Dutch Shell (RDS.A - Free Report) cut its dividend for the first time since World War II to weather the historic oil price crash and save funds. Meanwhile, Zacks Rank #3 (Hold) BP plc (BP - Free Report) was forced to slash its payout after a decade.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

However, industry observers see the recent dividend hike by Kinder Morgan and previously by ConocoPhillips (COP - Free Report) as a sign of confidence in the outlook for oil prices. While all eyes will be on U.S. supermajors ExxonMobil (XOM - Free Report) and Chevron (CVX - Free Report) , it is unlikely that any of them will take their dividend down this time around amid WTI crude’s new-found stability at around $50 per barrel.

The major midstream players — being largely insulated to fluctuations in commodity prices — have managed to maintain their distribution levels thus far. Further, their relatively steady coverage and improving commodity price visibility should represent a more predictable midstream payout scenario in the fourth quarter.

Shale Producers in the Spotlight

Most indicators show that energy could be on a slow but steady recovery path. Currently at around $54 per barrel, WTI oil prices are at multi-month highs. With this firmed-up price and some previously shut-in production coming back online, shale operators could surprise on the upside.

As output from the unconventional plays look set for an uptick, all eyes will be on the companies working in the Permian Basin — America’s hottest and lowest-cost shale region, and by far the primary driver of crude production in the United States. The improvement in oil prices has prompted these firms to shore up drilling activity, leading to improved cash flows and increased chances of an earnings beat.

Will Macro Recovery Support the Sector in 2021?

Following the coronavirus-induced depths of the second quarter, the sector rebounded a bit in the July-September period on rebalancing supply/demand fundamentals. While the fourth quarter isn’t going to be strikingly better, we expect some improvement based on the uptick in oil prices, favorable year-over-year comparison in natural gas realizations and relatively steady production.  

The quarterly announcements will also present an opportunity for the companies to highlight the actions taken in response to the crisis and how these will help them adjust to the new normal. With the most encouraging macro backdrop in months and optimism around the vaccines, investors will be looking ahead to company-level improvements in the outlook.

An effective way to gauge a firm’s strength and resilience is to look out for improved guidance. Of particular interest will be cost-reduction initiatives, updates on free cash flow, and upward revision in estimated production.

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