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Oil & Gas US E&P Outlook: Supply Glut Raises Concerns

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The Zacks Oil and Gas - US E&P industry consists of companies based in the United States focused on exploration and production (E&P) of oil and natural gas. These firms are engaged in finding hydrocarbon reservoirs, drilling oil and gas wells, and producing and selling these materials to be refined later into products such as gasoline.

Let’s take a look at the industry’s three major themes:

  • There is increasing evidence that a fundamental change is occurring in the oil market. WTI crude, the American benchmark, popped above $76 a barrel and was trading at multiyear highs in early October. A looming shortage of the commodity on Iran sanctions helped in driving oil prices higher. Now, in a reversal, oil is facing a two-pronged attack: rising supply from major producers and fear that an economic slowdown will dampen the outlook for demand. Oil’s troubles helped send the index into a tailspin, leading to a 30% drop from recent highs. Even the OPEC-led supply cuts look unlikely to end the market surplus. While the future direction of crude's movement is anybody's guess, it might be prudent for investors to maintain caution in these uncertain times — either withdraw for a while or look for fundamentally sound stocks.
  • Meanwhile, natural gas prices are on a tear. Prices are up around 55% since the start of the year and soared 41% last month, making it the market’s best-performing commodity of November. Natural gas recently broke the $4 per MMBtu mark for the first time in four years with cooler weather conditions resulting in strong demand for the heating fuel. Despite skyrocketing production, natural gas entered the winter season with stockpiles at their lowest in 15 years. If the current (2018-2019) winter turns out to be colder than normal, the surge in expected demand — in the face of relative deficit of natural gas inventory — could trigger a large rally in the commodity's price.
  • Over the past few years, energy producers worked tirelessly to cut costs to a bare minimum and look for innovative ways to churn out more oil and gas. And they managed to do just that by improving drilling techniques and extracting favorable terms from the beleaguered service producers. Moreover, driven by operational efficiencies, most E&P operators have been able to reduce unit costs and live within their cash flows. All of these factors, together with production growth and capital discipline have resulted in surging free cash flows. With cash generation expected to remain robust even at relatively low oil prices, there is strong potential for greater return of capital to shareholders through dividend growth and stock buybacks.

Zacks Industry Rank Indicates Rough Times Ahead

The Zacks Oil and Gas - US E&P is a 77-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #156, which places it in the bottom 39% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dim near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic on this group’s earnings growth potential. Since Jul 31, 2018, the industry’s earnings estimates for the current year have decreased by 3.2%.

Despite the bleak near-term prospects of the industry, we will present a few stocks that you may want to consider for your portfolio. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Lags Sector & S&P 500

The Zacks Oil and Gas - US E&P has lagged the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.

The industry has declined 19.1% over this period compared to the S&P 500’s fall of 0.1% and broader sector’s decrease of 8.6%.

One-Year Price Performance

Industry’s Current Valuation 

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing oil and gas exploration and production stocks, the industry is currently trading at 7.14X, lower than the S&P 500’s 10.21X. It is, however, well above the sector’s trailing-12-month EV/EBITDA of 5.13X.

Over the past five years, the industry has traded as high as 16.67X, as low as 4.11X, with a median of 7.82X, as the chart below shows.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio


Bottom Line

Global oil supplies are looking plentiful and are expected to outstrip demand at the beginning of 2019. Predictions of more crude coming to the supply side through record production in the United States have added to the bearish sentiment on the market. Even the demand side looks jittery with OPEC forecasting weaker consumption.

However, one must note that there is still an air of uncertainty over the impact of the Trump administration’s sanctions against Iran. While exports out of Iran are likely to decline gradually, the much talked-about waivers to some of the country’s biggest buyers of oil are only temporary in nature. Fast-falling production in Venezuela, signs of robust demand in China and OPEC-led supply cuts should provide further support to crude prices.

Natural gas futures, meanwhile, are likely to soar on tight supplies amid expectations of strong winter weather.

We are presenting two stocks with a Zacks Rank #1 (Strong Buy) and two with a Zacks Rank #2 (Buy) that are witnessing positive estimate revisions. These companies are well positioned to gain amid the prevailing challenges.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Cabot Oil & Gas Corp. : This Houston, TX-based upstream operator focuses on high-impact natural gas-focused drilling in the Marcellus Shale. Cabot Oil & Gas carries a Zacks Rank #1 and has an expected earnings growth of 13.4% for the current year.  Over 60 days, the company has seen the Zacks Consensus Estimate for 2018 increase 9.7%.

Price and Consensus: COG


SilverBow Resources, Inc. (SBOW - Free Report) : This Houston, TX-headquartered oil and gas explorer — focused on the Eagle Ford shale located in South Texas — also has a Zacks Rank #1. Over 60 days, the company has seen the Zacks Consensus Estimate for 2018 increase 11.3%.

Price and Consensus: SBOW


Gulfport Energy Corp. (GPOR - Free Report) : This Oklahoma City, OK-based energy finder’s asset base – primarily focused on natural gas – is concentrated in the Utica Shale of Ohio and the SCOOP play in Oklahoma. Gulfport Energy carries a Zacks Rank #2 and has an expected earnings growth of 29.1% for the current year. Over 60 days, the company has seen the Zacks Consensus Estimate for 2018 increase 15.9%.

Price and Consensus: GPOR


QEP Resources, Inc. (QEP - Free Report) : This Denver, CO-headquartered oil and gas explorer — with operations primarily in Texas, Louisiana and North Dakota — also has a Zacks Rank #2. Over 60 days, the company has seen the Zacks Consensus Estimate for 2018 increase 150%.

Price and Consensus: QEP


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