A.I. Power Shortage. Plus, Oil & Gas Stock Picks

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Energy is not going away. The energy transition has effectively failed or been challenged, and that's going to take decades to really materialize, and technology is still not there.

Hello and welcome to the Barron Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Gabriel Sorbara. He's an analyst with an investment bank called Seabird William Schenck, and he covers energy, and he's pretty bullish on oil and quite bullish on gas. We'll hear why And Gabriel will tell us about his favorite stocks. It's finally a week where we don't talk about artificial intelligence, except that it's kind of about artificial intelligence. And by kind of, I mean totally. We'll come to that. Listening in is our audio producer Jackson. Hi, Jackson.

Hey, Jack.

You shared with me a little utility fun fact. Just the other day. What was your— what was your fun fact about utility stocks?

Well, in the past month, the Utilities Select Sector SPDR Fund—

this is an ETF, a basket of utility stocks.

Yes, it's up 15.5% in the past month.

Come on, how much is the S&P up?

5.1%.

Crushing the market. Utility stocks, who would have thunk? You buy them for the big dividend yields, you know they're going to be sleepy. But here they are beating everything in sight.

And highly regulated, too. So that's, that's kind of odd.

Well, let's talk about that. Let's, let's get to the grid. Let's talk about the grid, shall we?

Sounds good.

1,250 gigawatts. That's how much electricity we're producing here in the United States. Using 9,200 generating units. Is that a lot? I don't think it's a lot. I think it's maybe not enough. It sounds like it's not enough. I'm taking these figures from a recent report by BofA Securities, and the title of the report is Scale Up or Power Down. And it's talking specifically about artificial intelligence. You know how we used to say about cryptocurrency that, you know, everybody's using high-speed computers to do all this crypto mining around the world and it's using tons of electricity and where's all this electricity going to come from?

Yes, I remember. And it's still going on. Bitcoin's currently between Poland and Thailand in terms of electricity consumption. And in total, it's right around where it was in the 2022 peak.

Well, thanks a lot for that, Bitcoin. That sounds a little wasteful. I'm not going to lie. It sounds a little frivolous. And I'm looking at something that says we have the fastest electricity inflation in 4 decades. In the US, and putting those two facts together is not making me happy.

Yeah, anecdotally, the Tesla Supercharger near my house went from around 26 cents a kilowatt to now over 50 cents a kilowatt in the past 9 months or so.

That stinks.

Yeah, I can still get to 26 cents a kilowatt if I charge between midnight and 4 AM.

Midnight, and it's located how far from your home?

It's about a mile.

I mean, just bring a— either bring a book or a bicycle, one of the two. Sorry, buddy. I'm not even sure that we've seen the worst of it. Over the past 10 years, BFA says power demand rose just 0.4% a year, but over the next decade, the growth rate is expected to be 2.1% to 2.8% per year, somewhere in that range. They said expected future demand of 70 gigawatts by 2030 is like adding another state of Michigan to the grid every year. And we're not talking about just crypto driving that demand. We're talking chiefly about artificial intelligence, all those high-speed computers that we're adding to crunch through all that data and serve up our every demand in an instant. When people ask for a picture of Jackson, what are you searching? What kind of mashup lately are you searching for?

Yeah, like a concept car made out of Jell-O.

Delicious. Okay. If we're expected to need 70 more gigawatts of generating capacity by 2030, the estimate is that we're only going to come up with 55 to 60. There are regulatory and permitting and political obstacles. There are constraints for new energy like wind and solar. You really need battery storage to make them work well, and battery storage is just a heck of a lot more expensive than traditional energy sources like gas, natural gas. B of A writes, round one winners from new tech demand like data centers, hyperscalers, and chipmakers are well-owned already. Further investments in those beneficiaries should be made contingent on a realistic path to expand the power supply. In other words, the big new digital darlings can still win, but the ruddy old real world may have to win first. Put differently, it points out that the Magnificent Seven tech stocks trade at 37 times earnings, but without power, What would that price-to-earnings ratio be? So the strategists there have come up with a bunch of picks from the old economy. We're talking about individual stocks and exchange-traded funds. They say this future demand for artificial intelligence, it's not priced in there. The old economy stocks, they say, are undervalued, undercapitalized, and under-owned. Old economy sectors make up only about 15% of the S&P 500's market cap. During the 20th century, the average was 40%. What kinds of companies are we talking about? There are miners like BHP Group, that's BHP, and Freeport-McMoRan, that's FCX. There's a commodities ETF, Direxion Auspice Broad Commodity Strategy, the ticker there is COM. Another ETF for uranium, Global X Uranium, ticker URA. B of A says that uranium is in its third secular bull market and that you could get 10 gigawatts of additional electricity from existing infrastructure without new building. Some more of the picks— there are utilities: Entergy, that's ETR, and Public Service Enterprise Group, that's PEG. There are industrials like Eaton, ETN, and Caterpillar, CAT. And there are oil and gas picks. I'll give you one of the ETFs there: Invesco Energy Exploration and Production, ticker PXE. And that's as good a place as any to switch to the conversation I had recently with an oil and gas exploration analyst. Jackson, should we start that conversation now? And then just when people are whipped up into a frenzy of excitement, I'll break in and say, hey, we've got to take a commercial break, folks. Or should we get the break out of the way now and then play the whole conversation? It's kind of like eating your veg first. What do you think?

I think you've talked enough right now. We should just go to the break.

Done.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks. Balance your trading strategy by adding futures. CME Group helps you manage risk and capture opportunities in all market environments. Capitalize on around-the-clock access to highly liquid global futures and options markets across all major asset classes. Visit your online broker to get started. See what adding futures can do for you at cmagroup.com/podcast. Derivatives are not suitable for all investors and involve risk of losing more than the amount originally deposited and any profit you may have made. This is not a recommendation or offer to buy, sell, or retain any specific investment or service. Welcome back. We've been speaking about rising electricity demand stemming from artificial intelligence, and that was one of the factors mentioned in a conversation I had recently with Gabriel Subara. He's an energy analyst at Seabird Williams Shank. He'll also speak generally about what's likely next for oil and gas and some of his favorite stocks. Jackson, is there anything I should pre-explain Presplain. Do I have any presplaining to do about this conversation about oil and gas, about the futures curve? Some futures curve stuff, a little backwardation.

Contango, which I can only assume is some sort of dance.

You have oil futures and you can make a chart of those futures for coming months and years, and they tell you what the market says is likely to happen with the oil price. And if it says that the oil price is likely to fall, That's called a backwardated futures curve. And it says it's likely to rise. That's called contango. I don't know why they're called such different things. Why isn't the opposite of backwardation forwardation? Or why isn't the opposite of contango protango?

Sin tango would be the without. Yeah. So con is with, sin in Spanish is without.

Oh, that just needed one—

Tango being the Latin dance.

It just needed one extra leap of intelligence that I couldn't—

There was a spark, but it sputtered and went out before I could get there.

I wasn't thinking different languages. Okay.

There's also NGLs, which I can assume is the slang for not gonna lie.

Not gonna lie. Or natural— What the really cool kids use it for is natural gas liquids. That's where you get your ethane and your propane and your butane and all your favorite anes. I think the rest we cover along the way. Oil and gas wells. Sometimes there are wells that are primarily oil or primarily natural gas, but often when you're drilling for one, you get the other. Often you're drilling for oil and you get a lot of gas. Okay, so let's listen. I started out by asking Gabriel, what's next for oil and gas prices?

With oil, you have pluses and minuses, right? The reason I'm positive oil is, I mean, you've seen a pullback here recently. You've seen some geopolitical risk maybe come out of oil. I think there's a good floor under oil. I think there's a lot of positives from just monetary policy. I think OPEC+ continues to hold production levels. Even with the pullback now, I think it's more likely that in the early June meeting, they hold their production quotas. And there's also concerns about them actually being able to produce the volumes that they're trying to target. On the negative side, you have a lot of OPEC spare capacity, and that's a concern that investors always have with oil. The curve is backwardated, so when you look at an A&P company, your profitability kind of erodes.

Just for the benefit of people who might hear this and they don't know what that means, when you look at the futures curve, the prices for oil now are higher than the prices that are suggested several months down the road. So the market is saying that the oil price is going to fall. Should we believe that?

Historically, it hasn't been accurate, and the front month I feel has been a better indicator of the future. It is steeply backwardated when you look out to '27, '28. I think you get down to mid-$60s oil. I think a better mid-cycle range is probably in that $65 on the low end to probably $80. I think that's a pretty healthy level long-term, and I think OPEC's It's going to target staying within that range.

So I show Texas crude at about $79 a barrel. You mentioned $60 to $80. I gather that at today's prices and anywhere in that range, the companies can make good money going forward?

They do. The business model for EMP companies has evolved. And today we're in a period where companies have dialed back activity to maintenance mode or low single-digit growth. And they're harvesting that free cash flow. And it's a lot of free cash flow. The model for E&Ps is a lot healthier, a lot better. Balance sheets are in really good shape. Companies have consolidated, right? And that's made companies bigger, better with deeper inventory, right? As you slow down activity, you're actually— your inventory life gets extended, right? Instead of, you know, if you're drilling 10% fewer wells every year, you have more longevity as a company. And that's always a concern with EMPs, right? Because they're depleting assets. But now companies are extending inventory. You've seen a lot of large transactions. Companies are healthier. They have better inventory. Capital efficiencies also have improved. So the sector to us looks very attractive. And the S&P weighting continues to remain low at like 4% or so.

What should it be?

It's tough to say. You know, when I started the business in 2005, I think it was around 15%. You know, it really depends what the tech sector does. And tech sector, I think the weighting is around 30%. And I think you could see the EMP sector, energy sector in general, take some of that, you know, as there is a market rotation. You know, that could be a function of inflation and higher rates. And You know, that could have some people sell their high-growth companies and rotate into kind of the, the kind of the old-school, you know, energy companies. Energy is not going away. The energy transition has effectively failed or been challenged, and that's going to take decades to really materialize. And technology is still not there. And so I think you're seeing investor flows come to the sector. Again, a lot of that flow has gone to natural gas. But a lot of these oil companies produce a ton of gas. When you produce a well, there's also gas and NGLs in the reservoir that you're recovering. So you're recovering other hydrocarbons, right? And so in addition to the oil, you're getting the benefit of gas and NGLs.

So your outlook for oil sounds pretty positive from an investor standpoint, and you call oil the high-value hydrocarbon, yet you say that you're even more optimistic about the outlook for gas. Why is that?

Yeah, so gas, I think, has many tailwinds. The big demand pull that's in discussions right now among the investment community is from AI data centers, and power generation could be a huge driver. There's some big estimates out there, up to 30 BCF a day of incremental demand by 2030. And, you know, we produce around 100, 100 BCF a day. So that's a huge uplift if those numbers actually materialize. Also, you have LNG export demand picking up. There's a lot of projects coming online in the next few years, and so that demand will pick up significantly.

And just to connect the dots here, you're talking about burning natural gas to produce electricity, which will be used to power all these data farms running AI applications. Do I have that right?

That's correct. Yeah. And so a lot of that, those are in kind of that West Virginia area, I think is being discussed, you know, lately. And that's obviously very close to the Marcellus Shale and the Utica Shale. So a lot of the Appalachia companies are big beneficiaries of powering a lot of that energy need going forward. So that's a huge driver. And so the other thing I was going to point out was that, you know, the natural gas forward curve is in contango, where prices in the future are higher than they are today.

Okay. So as an investor or as an analyst, if you're going and you're looking for the best ideas within oil and gas, how do you prioritize? What are the things you look for? Do you weight oil versus gas production or do you look for certain company attributes? What do you do?

Yeah, I'm pretty much commodity agnostic. So I do look at the bottom line and today really focused on companies that can execute on the production front. And I think that's key. Top line is top of mind for investors. And if you can continue to beat on the production front, your company's gonna garner a premium valuation. And the second thing is really people playing again that natural gas theme because you get very few of those in the EMP sector, or I guess in recent years there's been very few of those. The sector is, like I said, it's more mature, it's a little bit boring, right? The companies are maintenance mode to low single-digit growth. So when you look at our top picks, the names that we like, there's a mix of oil, gas names on that list. There's a mix of large caps and small caps.

Let me name some of these. You have 7 names on your note that you call your top picks. Maybe you can just give me a quick bullet or thought on each, if you would. The first one is CIVI, that's Civitas Resources.

This is a company that is trading at a discount valuation. And I think the reason is that they're in Colorado and Colorado has regulatory risk. Those risks have really faded away recently with a recent bill that came out that should put an end to kind of some anti-oil and gas legislation and ballot initiatives through '28. So I think that risk is abating and that should result in a rerating. The other thing that this company is doing is they're executing in the Permian Basin. 1Q results were very positive. They beat across the board. I think you're going to continue to see execution going forward. They have one of the highest dividend yields in the group, and they also are doing opportunistic buybacks.

How about CTRE? That's Cotera Energy.

Yeah, this one is one that also is kind of more debate name, and it's trading at a discount valuation on our numbers. It has a very high free cash flow yield, and they have a really pristine balance sheet. They're in really good shape, and they're executing on the capital returns front too, which we like. So they're doing a lot of buybacks, and I think you see the potential for a lot going forward.

And then there's 3 here that you mentioned as a group: Chord, Devon, and Marathon. That's CHRD, DVN, and MRO.

Yes. And all 3 of those I think can execute on the operational front. They can beat on the production front. And I think all of those can deliver strong capital returns, a combination of dividends and buybacks.

2 more to go. One is SM Energy. The ticker there is SM.

Yeah, we just added this one to the list. 1Q results were very positive. They beat on the production front 1Q. They gave better than expected 2Q guidance. They lifted the full year '24 guidance. Going forward, you're going to see them execute, and I think consensus estimates have to move higher. This one is one of the cheapest valuation names on our coverage list. Balance sheet is no longer a concern like it was years ago. Their leverage is now very low. They're doing buybacks and they have a small base dividend. So this one looks very good for somebody who's kind of looking for a small cap name to add.

And lastly, Gulfport Energy, GPOR. That's another smaller one. And by smaller, I mean, looks like the market cap is about $2.7 billion. What do you like there?

This one has a very low float, which, you know, works against you, you know, when the market's going lower, but this one's a very healthy company. They did come out of bankruptcy a couple of years ago. They restructured. They look very healthy today. The balance sheet is underlevered. They generate a lot of free cash flow. They're very well hedged into '25, and therefore their breakevens are down to like a dollar maybe on natural gas on per MCFE. And so this company that has the potential to return a lot of cash back to investors through buybacks They've talked about allocating nearly all of their free cash flow to buybacks going forward. And when you run those numbers, you can see nearly 50% of the share count get reduced by 2028. That means the stock's going to move higher in that scenario. So the company's obviously going to push the stock higher because they're doing buybacks. The risk on this one is that they do an acquisition. I don't think that's necessarily negative. Because that will give them scale and that will obviously bring in some more investors into the name. So, you know, some of that free cash flow could end up being used for an acquisition, which I think they're going to be very prudent in what they do. But yeah, again, that could be a risk that near-term maybe hits the stock. Longer term, it probably will be positive because I do think they'll do something accretive. A lot of the transactions we've seen from the industry over the past few years have been accretive transactions. They're not doing the transactions that they did back 5 years ago where they're buying a ton of acreage, adding rigs. Today, it's really you buy something, you extend your inventory, it's core inventory, it's accretive to what you have, and you're not impairing the balance sheet. So you're maintaining that low leverage. And any deal that gets done these days is allowing for even greater capital returns because it's lifting your free cash flow yields.

I hear you mentioning stock buybacks and free cash flow and things that suggest that these companies are are generating more money than they need right now to keep things going, which sounds like a promising sign. How would you characterize the valuations that you're seeing now relative to, let's say, you know, your time covering these stocks? Are, are the discounts particularly attractive right now for these shares, you know, compared with the rest of the market?

So when I started, it was 2005. And that was the beginning of the shale boom. And that was a different time. You know, you kind of went from that period, the beginning of the shale boom, where people were discovering some of these plays, into kind of a growth period where companies were acquiring. They were outspending significantly. Multiples were high because people were excited about the growth prospects going forward. We've evolved over the past 20 years. And so the key metric today is no longer NAV and really growth. It's what's your free cash flow yield? What's your capital return? So I mean, you can't compare it to 2005 because these companies were outspending significantly, had no free cash flow. And even 4 or 5 years ago, these companies didn't have free cash flow. This is a phenomenon that's very recent, past 2, 3 years that you've seen this model really change to where it is today. And again, it's very healthy, but investors do want growth. You have to kind of acknowledge that. And when you have growth, you can argue higher multiples like you're seeing in the tech sector investor today. But the companies are very cheap. They're very cheap to, I think, on a relative basis where they were 2, 3, 4 years ago. But again, you know, the multiple should rerate higher as investor flow comes to the group. And I think it will. And as the energy weighting moves higher, it's been a group that's been— we've been very difficult over the past 15 years and it feels like it's been a consistent decline over the past 5 to 10 years. And we're coming off lows, so we've outperformed here year to date. But I think there's a lot more outperformance ahead from this group because energy is vital, and we're starting to realize that the energy transition is still very early and challenging, right? And it's going to take some time.

Thank you, Gabriel. Jackson, you know, $80 a barrel oil— you remember that a couple of years ago I replaced these two big, uh, home heating oil tanks in my house with geothermal power, which you'd think I'd be rolling in the savings. But what happens is— oh no, what happens is you don't burn oil, but you use a lot more electricity in winter. And I did that just in time for the fastest electricity inflation in 40 years. So not really— I wouldn't say I'm rolling in the savings. So then what I did was to have the last laugh or to double down on dumb, whichever it is. I replaced these two fireplaces with high-efficiency fireplaces. They're kind of— they operate more like wood stoves. So now I'm using wood for a lot of the heat in winter. But that means that there is definitely going to be hyper woodflation over the next— whatever I decide to do, that's the thing that turns expensive next. It's following me.

You'll be chopping wood and I'll be sleeping in the Tesla Supercharging parking lot.

Thank you all for listening. Jackson Cantrell is our producer. If you have a question for the podcast, you can tape it on your phone. You can use the voice memo app and then you send it to jack.hough@barons.com. You can follow this podcast on Apple Podcasts, Spotify, YouTube, wherever you listen. If you want to leave a comment about the podcast, if it's been welling up inside of you all these years and you just can't hold it in anymore, I think you can do that on Apple. You can probably do it on YouTube too. I'm not going to look over there. People are crazy on YouTube. Thanks, and we'll see you next week. Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.