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U.S. crude oil prices jumped to their 16-month high on Friday, ending above $108 a barrel. The surge in the WTI (West Texas Intermediate) – a benchmark for domestic producers – is likely driven by the ongoing unrest in Egypt that could destabilize the resource-rich Middle East and tighten the global supply picture. The encouraging employment statistics, signaling a strong U.S. economy, have added to the bullishness.
On top of this, the U.S. Energy Department's weekly inventory release showed that crude stockpiles fell sharply for the third time in as many weeks amid consistently climbing refinery runs. In fact, oil supplies have plunged by a cumulative 27.12 million barrels since the week ending Jun 21, 2013 – from 394.14 million barrels to 367.02 million barrels.
The strong rally in WTI prices has pushed it above Brent – the European counterpart – for the first time since Aug 2010. The elimination of the so-called ‘Brent-WTI spread,’ which was as high as $23 a barrel in Feb and $10 in early Jun, also points to new/improved pipeline capacity that has allowed the crude glut at the Cushing oil-storage hub in Oklahoma to be unlocked.
With spot crude price pushing through $100 a barrel, brokerage analysts are likely to upgrade their forecasts on oil-weighted companies and related support plays, leading to positive estimate revisions.
While all crude-focused stocks – including behemoths like Exxon Mobil Corp. (XOM - Analyst Report) and Chevron Corp. (CVX - Analyst Report) – stand to benefit from rising commodity prices, companies in the exploration and production (E&P) sector are the best placed, as they will be able to extract more value for their products.
Top 3 Crude Oil Plays Right Now
In particular, we suggest exposure to small-cap, undervalued E&P players like Matador Resources Co. (MTDR - Snapshot Report) and Memorial Production Partners L.P. (MEMP - Snapshot Report) that enjoys the benefits of crude oil price leverage, while sporting a Zacks Rank #1 (Strong Buy).
Dallas TX-based Matador Resources, with current focus on the high-return Eagle Ford shale formation in South Texas, is expected to witness earnings growth of 180% in 2013 and 51% in 2014. Moreover, a price-to-book (P/B) ratio of just 1.9 suggests that the stock is still undervalued.
On the other hand, upstream partnership Memorial Production Partners possesses a diverse portfolio of mature, long-lived properties in East Texas / North Louisiana, South Texas and offshore Southern California. Based on the success of the firm’s acquire-and-exploit policy, analysts are predicting a solid long-term earnings growth of more than 7%. Moreover, units of Memorial Production Partners are going for about 12.7x the estimate for 2013, a 69% discount to the peer group average of 40.5x.
One may also capitalize on this opportunity with the related business sector of energy equipment service providers. Our top pick in this space is Dril-Quip Inc. (DRQ - Analyst Report). This Zacks Rank #1 (Strong Buy) offshore drilling equipment maker boasts of highly engineered drilling and production equipment for deepwater severe-service applications and harsh environmental conditions.
Shares of Dril-Quip are going for about 25.2x the estimate for 2013. Though the stock looks a bit pricey, it should not disappoint investors given the company’s long-term expected earnings growth of 15%.