A steady drawdown of U.S. supplies, healthy demand and ongoing OPEC-led production cuts have driven oil prices higher. Crude has been inching its way back up after falling sharply from $100 a barrel in 2014, to a low of $30 in 2016. The robust fundamental backdrop, which we expect to further strengthen over the course of this year, has brought life back into the sector.
As a proof, over the past four quarters, the number of rigs searching for oil in the country have been surging. According to Baker Hughes, a GE Company’s closely watched weekly report, oil rig count was 800 last week, up substantially from the year-earlier level of 609.
Apart from shrinking supplies and strong consumption, the lower corporate tax rate following the Trump administration’s new legislation is likely to provide a recurring boost to the profits of many energy firms, and subsequently to their stocks.
Oil’s recovery to $65, predictably, has had a positive effect on stocks in the sector. In particular, savvy investors might view the price bump as the impetus the stocks need after freefalling for more than three years. Undoubtedly, still a long way to go, but improving crude prices may have already primed certain energy producers and linked entities for upward momentum.
Overall, with crude trading near multi-year highs, investors can once again buy into companies that look like pretty compelling investments in the current price environment.
High Quality E&P Names Leading the Way
Oil prices have gained almost 50% since falling to a ten-month low in late June 2017. The rebound has been fueled by dwindling oversupply concerns.
While all crude-focused stocks stand to gain from the oil rally, 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.
Moreover, the firms boast conservative balance sheets with enough cash on hand and manageable leverage. This provides them ample flexibility to make acquisitions or grow internally. Moreover, driven by operational efficiencies, these entities have been able to reduce unit costs -- an impressive achievement amid the tight realization scenario.
Apart from Zacks Rank #1 (Strong Buy) Continental Resources Inc. (CLR - Free Report) , we advocate the likes of Penn Virginia Corp. (PVAC - Free Report) and Wildhorse Resources Development Corp. (WRD - Free Report) .
(You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.)
Recovering Crude and Leaner Strategies Pay Off for Integrated Majors
2017 turned out to be a banner year for the integrated majors as they benefited from their scale and diversification, resulting in the strongest returns on capital in the industry.
More importantly, the companies were able to cover their investment and payouts with cash from operations -- something investors really want right now. In fact, riding on improving commodity prices, stronger production outlook and healthier cash flows, they look poised to continue the momentum in the coming years.
The integrated players have also reaped benefits of cost-containment strategies adopted during the historic downturn period. They focused on realigning their business models to a more lean and efficient structure so as to stay competitive in the long run. They engaged in reducing headcount, streamlining operations, divesting non-core projects, slashing capex and operating costs to adapt to the weak pricing environment and bolster their financials.
Cash flow from operating activities, which is a key metric to gauge the financial health of the firms — the oil majors, was the highest in 2017 since the downturn period. The companies generated enough cash to pay off debt along with funding capex and dividend payments.
Thanks to their integrated structures, entities like Statoil ASA (STO - Free Report) , Royal Dutch Shell plc (RDS.A - Free Report) , Chevron Corp. (CVX - Free Report) and BP plc (BP - Free Report) look poised for further growth and greater investor rewards. The companies are set for more cash generation and the top priorities of the CEOs are shifting from cost-containment efforts to boosting of shareholder value.
No Stopping Oil Producers in the Attractive Permian Basin
One oil-producing region that continues to attract investors is the low-cost Permian Basin - spread over west Texas and New Mexico. Experts say that it’s cheaper to drill and complete oil wells in the Permian Basin than most other major fields. Moreover, there are certain parts of the shale play whose well-returns are the best in the U.S. With crude prices still down significantly from their 2014 levels, well returns have become a very important metric to gauge profitability.
Such is the popularity of this unconventional basin that oil supermajors like ExxonMobil (XOM - Free Report) and Chevron have made the region mainstays of their future production. While ExxonMobil doubled its Permian Basin resource to six billion oil-equivalent barrels last year in a series of transactions, Chevron has allocated a massive $3.3 billion as capital expenditure for this lucrative region in 2018.
Permian’s attractive economics means that producers can still make money there at the current, just over-$50-a-barrel price. This is mainly because of the region's extensive pipeline infrastructure, plentiful labor and supplies, and relatively warm winters that makes year-round work possible. Most other domestic shale regions need prices above $60 to support new developments and expansions.
Though a number of companies have built sizeable acreage positions in the Permian Basin, we have shortlisted four of them – Pioneer Natural Resources Co. (PXD - Free Report) , Concho Resources Inc. (CXO - Free Report) , EOG Resources Inc. (EOG - Free Report) and RSP Permian Inc. (RSPP - Free Report) – that might fetch you outstanding returns.
Check out our latest Oil & Gas Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy.
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