One can only hope that some of the worst for energy is behind us, and that some of what is forecast to come doesn’t materialize. The correlation between energy stocks and crude oil seems to be slipping, or possibly broken, even with a backdrop of potentially escalating geopolitical events. Stock valuations are down hard, but have they yet discounted a worst-case scenario?

In an early July report, J.P. Morgan not­ed that E&Ps remain disconnected from the commodity, with the XOP (S&P Oil & Gas Exploration & Production ETF) under­performing the prompt futures contract for West Texas Intermediate (WTI) by roughly 27%. E&P efforts to shift to a strategy of generating free cash flow (FCF) “have yet to translate into equity performance” and improved multiples.

With the SMID-cap E&P group trading at about a two multiple discount to its large-cap peers, the report raised the possibility of a “capitulation” by some SMID-caps to take­over moves. This would be despite the fact they had built asset bases at costs that were “significantly higher than where the market is currently discounting their equity values.”

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