For our graphical review of energy equity performance in 1Q13, please click here: TDA Energy Performance Review
1Q13 was a very strong quarter for energy equities. Refiners & Marketers continued their strong performance from 2012 and were once again the strongest performing energy sub-sector in 1Q2013. Nevertheless, the sector has become increasingly volatile. The WTI-Brent spread that has contributed to strong margins for domestic refiners has shown some recent weakness. Also, the rising cost of renewable identification numbers (RINs) will add costs to some domestic refiners in the short-term. While we believe that these costs will eventually be passed on to consumers, the burden of this mandate has caused a headwind for these companies. Further, some refiners are starting to forecast the costs to comply with the Environmental Protection Agency’s (EPA) mandate to reduce the sulfur content in gasoline from 30 ppm currently to 10 ppm by 2017. Although these costs are not expected to be significant, it is yet another headwind that has caught the attention of investors. Despite these challenges, the refiners continue to be positioned as one of the long-term beneficiaries of the supply growth of U.S. domestic crude. While we are vigilant of short-term issues, we remain focused on long-term fundamentals that continue to look positive for this group of companies.
A host of MLP sub-sectors also provided very strong performance in 1Q2013. At least some of this performance appears attributable to these securities “catching-up” after a disappointing 2012. Despite strong fundamentals for many of the MLP sub-sectors in 2012, a number of exogenous events such as the 2012 U.S. presidential elections and “fiscal cliff” negotiations stoked investor fears that MLP tax benefits could be lost. As we have moved past these events, investors have been able to refocus on the strong fundamentals, yields, and distribution growth of several of the companies in these sub-sectors.
Similarly, after weak performance in 2012, investors also pushed E&P equity prices higher in 1Q13. Although E&Ps did get some support from WTI crude prices (+5.9%), it was surging natural gas prices (+20.1%) that helped to get investors excited about returning to low-cost natural gas producers. Marcellus weighted producers Cabot Oil & Gas (COG), Range Resources (RRC) and EQT Corp (EQT) all posted strong gains in 1Q13 as prices approached $4.00/MMBtu. In addition to support from natural gas prices, the acquisition of Berry Petroleum (BRY) by MLP E&P LINN Energy (LINN) is a noteworthy development in the E&P sub-sector. This acquisition marks the first time an E&P MLP has purchased an E&P C-corp. The low relative valuations of traditional E&P C-corps versus their E&P MLP counterparts provides an opportunity for E&P MLPs to make accretive acquisitions of E&P C-corps. A read-through of this scenario for other E&P C-corps with developed asset bases may help to close this valuation gap and provide a tailwind for E&P C-corps over the longer-term.