The price of oil looks primed to rally. There are two general groups of oil stocks to play that possibility—one with potentially big upside, and a safer group that still offers plenty of promise.
At just over $71 a barrel, WTI crude remains above a key “support” level in the high-sixties. The commodity has continued to see buyers come in at that level to prop it up for about a year and a half. That buying pressure should continue as the economy seems to be on a path to stabilize next year after seeing decelerating growth this year.
The Federal Reserve is widely expected to pause its interest-rate increases at its June 13-14 policy meeting as inflation has shown signs of cooling, although one more rate hike is possible in July as a result of the stronger-than-expected labor market. In any case, an end to the Fed’s monetary policy tightening means oil could keep rallying.
That should bring about stock gains for select oil producers, especially the highest “sensitivity” oil stocks, which gain the most when oil prices rise. The reason is rising oil prices mean rising sales, and, because these companies have a lot of fixed expenses, profits tend to rise even faster when sales climb. That’s especially true for smaller oil producers.
Recently, oil stocks as an entire group have been seeing less upside than usual when the price of the commodity rises. That’s because the shares have already surged from lows in the early days of Covid-19 lockdowns when the price of oil hit rock bottom. That’s why the highest-sensitivity oil producer stocks are worth a look—they could still get a boost from a breakout in oil prices, while less sensitive stocks’ gains might be a less spectacular.
Ovintiv
(OVV), with a market value of $8.3 billion, has been one of the highest-sensitivity oil stocks in Gerdes Energy Research’s coverage universe. According to analyst John Gerdes, the value of the firm’s estimates for Ovintiv’s free cash flow should have a roughly 55% sensitivity to the price of oil. WTI is up around 5% since the end of May, when it hit its key support level, while Ovintiv stock has jumped almost 8%, much better than the
Energy Select Sector SPDR Fund’s
(XLE) roughly 3% gain over the past two trading days.
Another oil producer to consider is the smaller
Kosmos Energy
(KOS), with a $2.8 billion market capitalization. It has a sensitivity of almost 35% to the price of oil, Gerdes says, and the stock has climbed about 11% over the last two sessions. Investors seeking bigger reward from rising crude prices could also look at the $5.4 billion oil producer
Matador Resources
(MTDR), which has a sensitivity of just over 30%.
The snag is that this all works in reverse. If oil prices—and sales—drop, these stocks and their profits would theoretically fall the hardest.
That’s why Gerdes also shows stocks with lower sensitivity, but still fairly high upside, given its estimates of future profits. The value of cash flows for the $63 billion
EOG Resources
(EOG) has a sensitivity of just under 25%, but Gerdes sees more than 50% upside to the value of its future profits.
ConocoPhillip
s (COP)—an oil major with a $120 billion market cap—has a sensitivity of about 25%, with the upside to the value of its earnings of about 40%, Gerdes says. The $23 billion
Diamondback Energy
(FANG), with a just over 25% sensitivity, has close to 45% upside.
Of course, oil stocks have already started to climb. Investors might want to catch them now, or buy on any weakness should the price of oil—and the stocks—stumble.
Write to Jacob Sonenshine at [email protected]
Read the full article here
