Stock, commodity divergence will ‘resolve to the upside,’ energy analyst says

Ben Cook, portfolio manager of the Hennessy Midstream Fund and the Hennessy Transition Fund, joins Yahoo Finance Live to discuss energy markets, the correlation between stocks and commodities, the energy transition, and oil demand in China.

Video transcript

BRAD SMITH: Well, turning now for a closer look at the energy sector, we're taking a look at WTI and Brent on your screen there as investors eye potential for easing of China's COVID restrictions as it pushes elderly vaccinations following widespread protests against strict curbs. Joining us now for more on the energy space, we've got Ben Cook, Hennessy Midstream Fund and Hennessy Transition Fund portfolio manager. Great to have you here with us on set today.

BEN COOK: Thanks very much.

BRAD SMITH: Absolutely.

BEN COOK: Thank you for having me.

BRAD SMITH: All right, so we've seen an outperformance in energy, of course, this year. Is that sustainable, from your view?

BEN COOK: Yeah, we think it is. If you think back over the last 18 months, these companies have redirected a significant amount of cash flow back to paying down debt, returning cash to shareholders in the form of dividends and share repurchases. And that's improved the financial quality of these companies materially. So we look at commodity fundamentals, what we expect for next year. And the financial condition of the company is we think that outperformance can be sustained.

BRIAN SOZZI: Now after a year of just strong runs-- we mentioned earlier in the show Marathon Occidental-- what makes a good oil stock? What metrics are you looking at?

BEN COOK: Yes, as part of our repeatable investment process in managing the Hennessy Energy Transition Fund, we look for a couple of things. We look for a high quality asset base that has a low cost structure, affording these companies with the ability to perform through the cycle. We're also looking for balance sheets that have a visible path towards improvement, and of course, we're looking for management teams that have been able to navigate through difficult times, as well as good times.

So that's part of our process. At this point in time, we're looking at both traditional hydrocarbon companies, as well as renewable technology or energy companies. And we see more attractive investment married across the traditional hydrocarbon value chain.

JULIE HYMAN: I want to pick up on the balance sheet improvement question because, I mean, haven't they already done all the improving that there is to be done? Many of these companies, right, over the past couple of years, and then going into now this stronger on a relative basis oil environment. Like, what more can they wring out?

BEN COOK: Now that's a great question. I think these companies, they have continued to lower debt, and to an extent, the additional cash flows being returned in the form of share repurchases and dividends. And so we continue to see the free cash flow yield of these companies screening very attractively. The large cap integrated group here in the US, free cash flow yields looking like 10%, the large cap US E&P sectors looking like 15%. So we continue to see strong cash flows being redirected towards the shareholder in the form of repurchases and dividends.

JULIE HYMAN: There's sort of a central puzzle when you're talking about these energy stocks, which is they've done very, very well. And oil has now rolled over, right? And as of yesterday, at one point, touched negative for the year. Talk to us about that divergence, why it's been happening. And it sounds like you think it's going to continue to happen to some degree.

BEN COOK: Yeah, we do. I think historically, there's been a close correlation between the commodity if you look at the 12-month future strip, the average of the future 12 months. And the commodity-- and the equities, they've tracked fairly closely. And again, we've seen that divergence occur because I think the market is acknowledging that, again, the financial condition of these companies has improved dramatically.

And over time, as we see continued strength in commodity fundamentals, we expect that divergence to actually resolve to the upside with commodity prices moving higher. And we think the equities will continue to enjoy the benefit of that strong commodity environment. It's not just for oil. It's for natural gas as well.

BRAD SMITH: What volatility do you expect if we do see even more movements in OPEC policy as well and where the production moves forward from here?

BEN COOK: Yeah, OPEC's wrestling with a variety of issues right now, obviously, weakness in China associated with zero-COVID lockdown policy. They're dealing with a global monetary system that's tightening post-pandemic. We continue to believe OPEC will be very supportive of crude prices. They'd like to see oil prices higher than where we are right now.

Our base case is that we see a range of crude oil prices between $80 and $100 into 2023. And again, that should support very strong operational and financial results for the companies in our investable universe.

BRIAN SOZZI: This has really been the year, I would say, of the electric car. And it's going to be decades of electric cars. Is that playing a role in your thinking of what stocks to pick and even to be exposed to the sector?

BEN COOK: Yeah, that's a great question. The trend towards electrification of the transportation sector is a megatrend theme. There will be a significant amount of capital that's focused on building out the infrastructure and inclusive of the cars that will be purchased by the base of-- the world consumer base.

Ultimately, though, if you map the value chain for many of the materials and metals that go into these cars and the infrastructure, there are some gating issues. We think there's impediments to widespread adoption. And over time, that will limit the pace of adoption. Ultimately, that will prolong the use of hydrocarbons, the need for liquid transportation fuels, and again, ultimately, that'll be beneficial for the traditional hydrocarbon sector.

JULIE HYMAN: Is there any either regulatory or investor sentiment risk? I mean, ExxonMobil is one of your top picks, right? And that definitely has been one-- because it's one of the biggies, right? It's been one of those that's been vilified by either those who are navigating into more ESG portfolios or those in Congress for political reasons. How do you factor in that risk?

BEN COOK: Yeah, there's always a risk with policy. That's part of the calculus in determining the risk-reward opportunity for the equities in the investable universe. And I think it's interesting what happened with the Inflation Reduction Act, is we got a significant extension of production tax credits and investment tax credits for the renewable sector that relieved a lot of the policy risk. And you would automatically think that would be beneficial for the renewable companies.

It's also beneficial for the traditional energy companies that are focused on carbon sequestration and capture, companies like Oxy that are pursuing direct air capture, Exxon that's pursuing a carbon capture hub along the Gulf of Mexico. These are projects that, prior to the Inflation Reduction Act, had some merit, but that merit has only improved with the Inflation Reduction Act. So policy's actually been favorable for those projects.

BRIAN SOZZI: Ben Cook, portfolio manager of the Hennessy Midstream Fund and Hennessy Transition Fund, good to see you. Thanks for coming to studio. Appreciate it.

BEN COOK: Thank you.