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Oil producer stocks could see some gains.
Callaghan O’Hare/Bloomberg
The oil price seems poised to rise. There are two general groups of oil stocks that can capitalize on that opportunity: one with a potentially large upside and a safer group that still holds great promise.
At just over $71 a barrel, WTI crude remains above a major “support level” in the high 1960s. The commodity continues to see buyers get to that level for about a year and a half to keep it afloat. That buying pressure should continue as the economy looks set to stabilize next year after seeing slowing growth this year.
The Federal Reserve is widely expected to pause its rate hikes at its June 13-14 policy meeting as inflation shows signs of cooling, although a rate hike is still possible in July due to the stronger-than-expected labor market. In any case, if the Fed’s monetary policy tightening comes to an end, oil prices may continue to rise.
That should yield inventory gains for select oil producers, especially the oil stocks with the highest “sensitivity”, which gain the most when oil prices rise. The reason is that rising oil prices mean increasing sales, and because these companies have a lot of fixed costs, profits often increase even faster as sales increase. This is especially true for smaller oil producers.
Lately, oil stocks as a whole group are seeing less upside than usual when the price of the commodity rises. That’s because the stock has already risen from the lows in the early days of Covid-19 lockdowns, when the price of oil bottomed out. That’s why the stocks of oil producers with the highest sensitivity are worth looking at: they could still get a boost from a blowout in oil prices, while the gains of less sensitive stocks might be less spectacular.
Ovintiv
(OVV), with a market capitalization of $8.3 billion, was one of the most sensitive oil stocks in Gerdes Energy Research’s coverage universe. According to analyst John Gerdes, the value of the company’s estimates for Ovintiv’s free cash flow should be about 55% sensitive to oil prices. WTI is up about 5% since late May when it reached its key support level, while Ovintiv shares are up nearly 8%, far outperforming the
Energy Select Sector SPDR fund
‘s
(XLE) up about 3% over the past two trading days.
Another oil producer to consider is the smaller one
Cosmos energy
(KOS), with a market cap of $2.8 billion. It has a sensitivity of almost 35% to the oil price, says Gerdes, and the stock is up about 11% over the past two sessions. Investors seeking greater reward from rising crude prices may also be eyeing the $5.4 billion oil producer
Matador Resources
(MTDR), which has a sensitivity of just over 30%.
The problem is that this all works in reverse. If oil prices – and sales – fall, these stocks and their earnings would theoretically fall the hardest.
Therefore, Gerdes also shows stocks with lower sensitivity, but still quite high upside potential given his estimates of future earnings. The value of cash flows for the $63 billion
EOG Resources
(EOG) has a sensitivity of just under 25%, but Gerdes sees more than a 50% benefit to the value of his future earnings.
ConocoPhillip
s (COP) — a major oil company with a market cap of $120 billion — has a sensitivity of about 25%, with an increase rate of about 40%, says Gerdes. The $23 billion
Diamondback energy
(FANG), with a sensitivity of just over 25%, has a rise rate of almost 45%.
Of course, oil stocks have already started to rise. Investors may want to grab them now, or buy them when the price of oil – and stocks – falls.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
