Worried about a volatile oil and gas market? Paradigm Capital's Ken Lin advises waiting for quality companies to take a hit before swooping in to stock up, and then taking profits on the way up to avoid being caught in future carnage. In this interview with The Energy Report, Lin outlines eight companies with underlying strength.
The Energy Report: Brent oil prices have been in the $60+/barrel ($60+/bbl) range for most of the last month, and West Texas Intermediate (WTI) has stayed above $50/bbl. Did oil establish a bottom? What indicators are you watching to see if the trend will continue?
Ken Lin: We probably reached a bottom at the $45/bbl WTI level. When you look at the fundamentals, nothing really works at the $40/bbl price. It also doesn't work at $50/bbl or $60/bbl. When companies continue to lose money at the current commodity price, that points to higher commodity prices later in the year. They'll probably settle out at some point.
TER: Are you worried about pressure from high storage levels?
KL: We do watch storage levels, but rig counts are the main thing we are looking at right now. Companies have reduced their capex budgets quite dramatically. We've seen cuts, in some instances, of up to 50% from the previous year's levels, and companies are continuing to reduce capex programs. Inventories are only a small part of the oil price picture.
TER: Based on that reality, what is the best way to blunt the pain during times like this?
KL: Oil and gas investors have experienced volatile cycles over the last five years. One way to protect yourself when you see movements of 50–100% in returns in a quarter or two is to take profit off the table. That can mitigate some of the ups and downs.
TER: Is that what you mean by "renting the space"?
KL: Because of the volatility and the short nature of the commodity cycles today, it's very hard to maintain a buy-and-hold strategy. Because we think the volatility will continue, my preference is to "rent" the names, meaning that you layer in positions over shorter terms and take profits off the table when there are big swings.
TER: We have been talking about oil; is the same true for gas? When will we see a bottom there?
KL: We are a little more bearish on the natural gas side, especially for 2015. We had a very cold winter, yet we've seen no reaction in natural gas prices. Summer to fall is traditionally a seasonally weak period for natural gas. We could see an average ($2–2.50/Mcf) AECO natural gas price for the rest of 2015.
Production of gas in North America continues to grow despite the fact that there has been no real capital allocation. There has been a stepwise change in well productivity because of technological improvements over the last five to seven years, so we now get more gas for less money even though fewer wells have been drilled. I don't think we'll see that dynamic change for the next five to 10 years. That could be the new normal. I wouldn't expect to see $10/Mcf—or even $6/Mcf—natural gas prices anytime soon in North America.