Better Conditions for E&P Companies

Last May, I discussed the possibility of a turnaround for oil & gas exploration and production (E&P) companies. Higher production and cost control measures led to positive earnings estimate revisions.

Three months later, the trend continues. Production levels, particularly in the North Sea and the Middle East, are increasing. Costs continue to be reined in. And analysts are raising their full-year profit forecasts further. During the past few weeks, 292 profit forecasts have been increased.

Commodity Prices Playing A Role

Rising oil prices are helping. Though significantly down from last year (crude peaked at $147.27 on Jul 11, 2008), crude rebounded throughout the second quarter. Furthermore, given the likelihood of economic expansion in the coming months, it is probable that a floor for oil prices has been set.

Natural gas prices may have hit a bottom. Natural gas started the year at $6.50 per million BTU and fell to under $4.25 by the end of the first quarter. The second-quarter drop was less severe, however, with natural gas ending June at about $4.

While there is still some weakness, a bottom seems to be setting.

Expenses Are Being Controlled

The biggest benefit to the E&P companies, however, has been costs.

CFOs have limited expansion to only what cash flows allowed. In addition, they've also worked to limit overhead costs.

The other positive factor is drilling costs. Apache's (APA) North American President, John A. Crum, noted on the conference call that his company "can drill and complete a well today for roughly two-thirds of last year's costs." In addition to higher demand last year for parts and services, several other commodities, such as steel, were also in a bubble.

Analysts May Have Been Too Pessimistic

Though conditions do seem to be improving for the industry, overly pessimistic profit forecasts are contributing to the upward revisions. Brokerage analysts factored in crude prices that were too low, underestimated cost reductions and incorrectly projected production rates.

We saw the impact of this with both the number of positive second-quarter surprises and the resulting increases in full-year earnings estimates:

• Apache (APA - Analyst Report) beat by 31 cents with earnings of $1.31 per share. Analysts subsequently raised their 2009 profit projections by 66 cents, resulting in a Zacks Consensus Estimate of $4.85 per share.
• Concho Resources (CXO - Snapshot Report) beat by 15 cents with adjusted earnings of 34 cents per share. Analysts subsequently raised their 2009 profit projections by 25 cents, resulting in a Zacks Consensus Estimate of $1.12 per share.
• Noble Energy (NBL - Analyst Report) beat by 11 cents with earnings of 66 cents per share. Analysts subsequently raised their 2009 profit projections by 40 cents, resulting in a Zacks Consensus Estimate of $2.82 per share.
• St. Mary Land & Exploration Company (SM - Snapshot Report) topped expectations for breakeven results with profits of 24 cents per share. Analysts subsequently raised their 2009 profit projections by 42 cents, resulting in a Zacks Consensus Estimate of 47 cents per share.
• Newfield Exploration (NFX - Analyst Report) beat by 20 cents with earnings of $1.28 per share. Analysts subsequently raised their 2009 profit projections by 43 cents, resulting in a Zacks Consensus Estimate of $4.47 per share.

CXO is a Zacks #1 Rank ("strong buy") stock. NBL, NFX and SM are Zacks #2 Rank ("buy") stocks. APA is a Zacks #3 Rank ("hold") stock. (Apache's rating is hurt by the fact that nearly one-third of the covering analysts have yet to adjust their profit forecasts. This, however, does leave open the possibility of more positive estimate revisions occurring over the next several weeks.)

All of these stocks belong to the Oil-US Exploration & Production industry group.

Related ETFs

Though there are several energy-related ETFs, iShares Dow Jones U.S. Oil & Gas Exploration & Production (IEO) provides the best exposure. The fund has a good combination of focusing on the E&P companies and a high level of average daily trading volume.

Zacks Premium and Zacks Elite subscribers can view the Zacks Industry Rank List at http://www.zacks.com/zrank/zrank_inds.php. This interactive list allows you to see all of the companies, and their Zacks Rank, within more than 200 industries. Shown below is the Zacks Sector Rank List, which shows the trend in estimate revisions on a broader scale.

Charles Rotblut, CFA, is the senior market analyst for Zacks.com. He can be reached at crotblut@zacks.com.

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