[Editor's note: A version of this story appears in the December 2019 edition of Oil and Gas Investor. Subscribe to the magazine here.]

The end of a year is often marked by key events, in some cases of drama, in oth­ers of default. This year was another disappointing year for energy through the end of October. However, with the start of November came a positive U.S. new jobs report, sparking a 3.7% rebound in West Texas Intermediate (WTI) to $56.20 per bar­rel and lifting at least momentarily the gloom over global oil demand.

But for much of 2019, sentiment was poor, with the S&P Oil & Gas Exploration ETF badly trailing both the broader market and crude prices.

Observers were sometimes left scratching their heads.

Early in the third-quarter reporting season, for example, analysts gave broad predictions of likely stock market reaction to E&P re­sults issued by Hess Corp. (“raises produc­tion guidance and lowers budget … again”), Concho Resources Inc., (“oil beat combined with cost improvements should drive out­performance”) and Matador Resources Co. (“can’t ask for much more, beats across the board”).

Unfortunately, the stock market reaction on the day after earnings release didn’t quite jive with the commentary. With no notewor­thy market gyrations (Dow Jones up 0.4%, WTI down 0.8%), large-cap Hess slumped over 4.4%, while SMID-cap Matador fell 5.9%. Concho, which had been down 22% on second-quarter earnings, was up 10% on the open, but gave back all but 0.6% of the intra-day gain.

Maybe that marked a low in investor senti­ment. But what will change sentiment?

“It’s not going to be valuation,” said one veteran analyst, noting historical metrics had been abandoned long ago. “The perception is there’s a glut.”

Geopolitical events remain a possible cata­lyst, albeit one likely viewed by the market as less impactful following Saudi Arabia’s abil­ity to re-establish production after the drone attack on its Khurais oil field and Abqaiq stabilization facilities. That said, few other Mideast producers likely have the same de­gree of redundancy that Saudi Aramco was able to demonstrate in its rapid resumption of production.

Relatively few headlines have been de­voted to what RBC Capital Markets has de­scribed as “a second Arab spring,” with three governments having fallen recently in the Middle East. Moreover, predicted the RBC report, “Iraq looks set to join the ranks of Lebanon, Algeria and Sudan, given reports that Prime Minister Abdul Mahdi is poised to step down and hold fresh elections.”

According to RBC, over 250 lives have been lost in a month during “spiraling pro­tests” in Iraq. As of early November, pro­duction was unaffected, “but oil workers are increasingly joining the demonstrations,” causing logistical challenges, said RBC. “We contend that the longer the Iraqi pro­tests continue, the greater risk to oil output given that Basra province has been the epi­center of the unrest.”

 

The deeper implications are that “Iran could be a big loser from the turmoil” in Iraq, and “it will fight hard to retain its significant influence in both Lebanon and Iraq,” ob­served RBC. “Such a strategy could in turn bring it closer to a direct confrontation with the U.S.,” which has a presence of around 5,000 troops serving in close proximity to the Iran-backed militias in Iraq.

Of course, geopolitical risk is something people tend to cite when times are tough and prospects are poor.

But for those willing to look out a little longer, fundamentals come into play. For ex­ample, Rystad Energy pointed to a resource replacement ratio of 16% for conventional resources through the third quarter of 2019. The ratio—indicating only one barrel being replaced for every six consumed—is “the lowest replacement ratio we have witnessed in the last two decades.”

But sentiment can be slow to turn in a mar­ket now over 50% driven by computer pro­grams. Concho was taken to the woodshed for disappointing second-quarter results, but in the third quarter was able to show a 20% improvement in drilling and completion costs over the first half of 2019. This helped Concho point to markedly higher free-cash-flow estimates going forward.

However, even as management cited many of the goals prioritized by investors—“sus­tainable oil growth, free cash flow and shareholder returns’’—Concho’s stock was unable to hold onto gains in an energy mar­ket one observer said is prone to “default to pessimism.”

With several weeks to go before year-end as of this writing, the question may be: Is some drama yet to unfold at year-end, good or bad, as often in the past? Or do we have to further endure a “default to pessimism” that has yet to run its course?