David Heikkinen, a managing director at the Houston-based asset manager Pickering Energy Partners, has been advising investors about oil and gas companies for decades, after working as an engineer at Royal Dutch Shell early in his career. Heikkinen thinks oil and gas companies are at a turning point as the energy transition takes place, and he expects current trends to be profitable for companies focusing on both old and new forms of energy. He spoke with Barron’s recently about where to find opportunities. An edited version of the conversation follows.
Barron’s: The transition to cleaner energy is putting pressure on oil and gas companies. But shortages of some commodities are sending energy prices higher. Is this a moment to buy oil and gas stocks?
David Heikkinen: What investors are getting with these stocks is a big return of cash.
Pioneer Natural Resources
[PXD] are paying variable dividends;
[COP] is doing a record amount of share repurchases. It’s a real wave of cash returns. You don’t really have long-only investors coming into the space. Value investors have seen the stocks go up nearly 100% and are probably thinking, “Should I be selling?” But the stocks have gotten cheaper, as the commodity has rallied faster than the shares. Investors ought to be reaping the rewards. But they’re not, and they’re not really engaged and involved in the energy space.
So, they should be getting in now, even after these enormous moves?
We see stocks that can more than double, just based on where their free-cash-flow yields are over the next three years. There are some gas stocks like
[EQT] that fit the bill, particularly given that their balance sheets have been repaired over the past 18 months. It’s wild to think Antero was a 70-cent stock, and now it’s 20 bucks and we’re still recommending it. But these things can double. One other name is
[CTRA], created by the merger of Cimarex and Cabot. It has the same potential.
Do you see oil names with that potential, too?
We see some stocks that can go up 50%.
[FANG] fits the bill. Pioneer and Devon can have that 30% to 50% upside just on next year’s numbers. Those are meaningful market-cap companies. There are smaller companies like
[TALO] that are down-liquidity and down market cap that are going to do multiples, like those gas stocks.
Will oil hold at $80 a barrel, and even rise in price from here?
We’re back at pre-Covid [price] levels without seeing jet-fuel demand come back yet. With inventory levels where they are now, with demand recovery and the supply discipline, I think we hold these levels, barring some sort of demand destruction. The supply-chain issues are going to be the key thing to watch. They could cause oil prices to not continue to go up. You’re seeing the supply-chain backup leading to bottlenecks. Every time you hear about a ship not sailing, or a train not moving, or a truck not driving, that’s demand destruction for hydrocarbons.
When you’re in a commodity crisis, there’s always an overcorrection on the other side at some point. And sometime in the back half of next year, the U.S. producers will fix their balance sheets completely. We’ve had 18 months of returning cash to shareholders. The world, President Joe Biden, Congress, and the general public will call on the U.S. to produce more oil, natural gas, propane, and natural gas liquids in 2022. The problem is investors want the U.S. producers to return cash, as opposed to ramping capital spending. It’s an unstoppable force meets immovable object event. I don’t know what will happen.
In the back half of 2022, going into 2023, you could start seeing an uptick on the supply-growth side again.
Energy companies have been reporting third-quarter earnings in the past couple of weeks. Do any results stand out to you?
[EOG] took a step forward. They increased their base dividend, paid out a special dividend, and have a $5 billion share-repurchase program. They’re signaling that they have the balance sheet in place; in the event of another Covid-like experience, where oil prices go negative, they’d be buying back the stock, hand over fist. They weren’t in a position to do that in 2020, given they had debt that was due. They are signaling that they’re going to be an essentially unlevered company going into the next cycle and focusing on returning cash. That’s pretty compelling.
On the other side, Continental Resources [CLR] kind of tipped their hand, as well, needing to buy Pioneer’s position in the Delaware Basin [a section of the Permian Basin in Texas and New Mexico]. That shows that they needed inventory in a brand-new basin. That’s a net negative. It probably says they’re going to do more transactions. It confirmed a belief that we had that the stock was relatively highly valued, very tightly held.
You’ve also been doing work on some “new energy” companies. Are you recommending stocks there?
It was about two years ago when we made a hard push into thinking about adjacencies. We picked up coverage of a company called
[EVA] with a buy. It’s a wood-pellet manufacturer; the wood pellets are a coal replacement. When you harvest trees, there’s a lot of leftover wood. It’s essentially a carbon-neutral fuel. You’re now burning that waste product from the timber industry, and pelletizing it and shipping it to displace hydrocarbons. Enviva is probably one of our favorites. You can supplement or replace the fuel at a coal plant or a natural-gas plant with wood pellets. We’re thinking about it as an alternative in the steel and cement industries, as well, where you’ve heard a lot of discussion about hydrogen as the alternative high-heat fuel.
Enviva just converted from a master limited partnership to a C corp. A lot of the ESG [environmental, social, and governance–oriented] funds didn’t own Enviva because it was an MLP.
Aren’t there environmental downsides to burning wood, too?
Essentially, you’re reclaiming the carbon. It isn’t carbon-negative, which is what a green or blue hydrogen could be. But it’s essentially a carbon-neutral fuel.
But doesn’t it send out particulate matter that’s harmful to your lungs?
That gets into the scrubbers needed on the power plants. It’s an enabler for eliminating all that coal without having to mothball all the coal plants. If you’re replacing coal, it’s always going to be better. A lot of those coal plants already have scrubbers on them. The wood burns cleaner than coal. Their renewable alternative to the coal business generates steady, predictable cash flow resulting in an attractive 5.4% dividend yield at current prices.
Do you favor any investments in solar energy?
On the solar side, we’re not as interested in the big utilities that are putting in solar panels. We prefer the enabling technologies in and around that. It’s kind of like the gold rush in the energy transition. You don’t necessarily want to own the companies that are installing the mines, or installing the wind farms or solar fields. You want to find the companies that supply the picks and shovels.
Whenever you put solar panels on a residence, you have an inverter to convert DC power to AC. There are technology companies that manufacture those inverters.
[ENPH] is one.
[SEDG] is another company that benefits from inverter demand. That’s where we see the opportunity.
And what about wind power?
We’ve been doing a bunch of work on [Danish power company]
[DNNGY]. What has been interesting about Orsted is the wind isn’t blowing as much globally. You’ve seen a 20% to 30% reduction in wind speeds, which then lowers their earnings power.
Does a reduction in wind speed kill some of the wind-power thesis?
It says you need to diversify. Orsted owns a bunch of North Sea wind farms. Whenever the wind doesn’t blow as much, maybe you want a little wind off New Jersey and Maryland in the future to get to that balance.
Do you own Orsted?
No. Our concern is that the return expectations are heading lower.
How should investors think now about owning energy, both old and new versions, in their portfolios? How much should they own?
If you’re running a mutual fund, legacy energy is a 2.5% to 3% weight in the index that you’re measured against. At this point, I think you ought to be above the weight for legacy energy. You could probably be twice-weighted.
The energy transition is going to see fivefold [as much capital investment as legacy energy]. Global capital investment in oil is about $600 billion this year, but it peaked in the 2014-15 time frame at $900 billion. For the energy transition, global investments are going to be between $3 trillion and $5 trillion a year for the next 30 years. What we’re preparing for and focusing on is finding those enabling technologies that are going to allow this level of global capital investment.
Most of the companies we’re looking at are pre-public. We did a call with a battery-technology manufacturer this morning that is in a Series B round [of fund raising]. We have another call coming up with a lithium silicon battery manufacturer. Some of the best opportunities are on the venture and the pre-public side. We’re trying to find those companies that might come public in the future.
Write to Avi Salzman at [email protected]