Oil & Gas Stocks May 'Feel the Heat' - Industry Outlook
29 April 2014 - 5:36PM
Zacks
OUTLOOK
Crude Oil
Positive economic data and geopolitical fears have helped oil
prices stay above the major psychological threshold of $100 per
barrel.
Crude’s recent run has been spurred by a spate of upbeat reports,
providing further evidence that the U.S. economy is coming out of
its winter freeze. This has prompted hopes for robust fuel and
energy demand in the world’s biggest oil consumer. The bullish
momentum has been further propelled by the continued standoff in
Ukraine that could disrupt supply from oil-rich Russia.
Sentiments were also helped by the Federal Reserve’s measured
Taper announcement. The central bank -- asserting that the U.S.
economy was strong enough -- reduced bond repurchases to $65
billion a month from February.
Partly offsetting this favorable view has been a spike in domestic
production -- now at their highest levels since 1988 – that has
ballooned crude inventories to 397.7 million barrels, the most on
record. The imminent resumption of oil exports from the Libyan
coast has also been a drag on prices.
The immediate outlook for oil, however, remains positive given the
commodity’s constrained supply picture. In particular, while the
Western economies exhibit sluggish growth prospects, global oil
consumption is expected to get a boost from sustained strength in
China, which continue to expand at a healthy rate despite some
moderation.
According to the Energy Information Administration (EIA), which
provides official energy statistics from the U.S. Government, world
crude consumption grew by an estimated 1.2 million barrels per day
in 2013 to a record-high level of 90.4 million barrels per day.
The agency, in its most recent Short-Term Energy Outlook, said that
it expects global oil demand growth by another 1.2 million barrels
per day in 2014. Importantly, the EIA’s latest report assumes that
world supply is likely to go up by 1.4 million barrels per day in
2014.
In our view, crude prices in the next few months are likely to
exhibit a sideways-to-bearish trend, trading in the $90-$100 per
barrel range. As North American supply remains strong and the
groundbreaking agreement with Iran makes it easier for the country
to sell the commodity, we are likely to experience a pressure in
the price of a barrel of oil.
Natural Gas
Over the last few years, a quiet revolution has been reshaping the
energy business in the U.S. The success of ‘shale gas’ -- natural
gas trapped within dense sedimentary rock formations or shale
formations -- has transformed domestic energy supply, with a
potentially inexpensive and abundant new source of fuel for the
world’s largest energy consumer.
With the advent of hydraulic fracturing (or fracking) -- a method
used to extract natural gas by blasting underground rock formations
with a mixture of water, sand and chemicals -- shale gas production
is now booming in the U.S. Coupled with sophisticated horizontal
drilling equipment that can drill and extract gas from shale
formations, the new technology is being hailed as a breakthrough in
U.S. energy supplies, playing a key role in boosting domestic
natural gas reserves.
As a result, once faced with a looming deficit, natural gas is now
available in abundance. In fact, natural gas inventories in
underground storage hit an all-time high of 3.929 trillion cubic
feet (Tcf) in 2012. The oversupply of natural gas pushed down
prices to a 10-year low of $1.82 per million Btu (MMBtu) during
late April 2012 (referring to spot prices at the Henry Hub, the
benchmark supply point in Louisiana).
However, things have started to look up somewhat following a frigid
winter that saw the heating fuels’ demand take off. This pushed
commodity prices to its highest level in 5 years earlier this year.
In fact, natural gas supplies are coming off their 11-year-lows,
prompting fears about the timely replenishment of the inventories
ahead of the next heating season, starting from November.
As such, natural gas’ near-term fundamentals remain sketchy, to say
the least.
ZACKS INDUSTRY RANK
Oil/Energy is one the 16 broad Zacks sectors within the Zacks
Industry classification. We rank all of the more than 260
industries in the 16 Zacks sectors based on the earnings outlook
for the constituent companies in each industry. To learn more
visit: About Zacks Industry Rank
The way to look at the complete list of 260+ industries is that the
outlook for the top one-third of the list (Zacks Industry Rank of
#88 and lower) is positive, the middle 1/3rd or industries with
Zacks Industry Rank between #89 and #176 is neutral while the
outlook for the bottom one-third (Zacks Industry Rank #177 and
higher) is negative.
The oil/energy industry is further sub-divided into the following
industries at the expanded level: Oil – U.S. Integrated, Oil and
Gas Drilling, Oil – U.S. Exploration and Production, Oil/Gas
Production Pipeline MLP, Oilfield Services, Oil – International
Integrated, Oil – Production/Pipeline, Oilfield Machineries and
Equipment, Oil–C$ Integrated, and Oil Refining and Marketing.
The ‘Oil Refining and Marketing’ is the best placed among them with
its Zacks Industry Rank #66, comfortably placing it into the top
1/3rd of the 259+ industry groups, where it is joined by the
‘Oil/Gas Production Pipeline MLP’ with a Zacks Industry Rank
#82.
The ‘Oil – U.S. Exploration and Production’ -- with a Zacks
Industry Rank #100 -- moves out of the top 1/3rd and into the
middle 1/3rd. The ‘Oil–C$ Integrated,’ ‘Oil – U.S. Integrated,’
‘Oilfield Services’ and ‘Oil and Gas Drilling’ also lie in the
middle 1/3rd, with Zacks Industry Ranks of #101, #101, #148 and
#164, respectively.
However, all the other sub-sectors -- Oil - Production/Pipeline,
Oil – International Integrated, and Oilfield Machineries and
Equipment -- are featuring in the bottom one-third of all Zacks
industries with respective Zacks Industry Ranks of #179, #192 and
#203.
Looking at the exact location of these industries, one could say
that the general outlook for the oil/energy space as a whole is
neutral-to-negative.
EARNINGS TRENDS
As far as overall results of the Oil/Energy sector is concerned, it
displays a mixed trend.
For the 32% industry components that have come out with their Q1
reports -- comprising 21.0% of the sector market capitalization --
earnings rose 13.7% during the March quarter, a substantial decline
from the 22.8% increase witnessed in the previous quarter. However,
there was some improvement on the revenue front, which was up 9.3%
in the first quarter as against a gain of 8.8% in the fourth
quarter.
The sector has also been erratic in terms of beat ratios
(percentage of companies coming out with positive surprises). The
earnings "beat ratio" was an impressive 71.4%, but the revenue
"beat ratio" was underwhelming, at 42.9%.
For more information about earnings for this sector and others,
please read our Earnings Trends report.
OPPORTUNITIES
Considering the turbulent market dynamics of the energy industry,
we always advocate the relatively low-risk conglomerate business
structures of the large-cap integrateds, with their fortress-like
balance sheets, ample free cash flows even in a low oil price
environment and growing dividends.
Our preferred name in this group remains Chevron
Corp. (CVX). Its current oil and gas development project
pipeline is among the best in the industry, boasting large,
multiyear projects. Additionally, Chevron possesses one of the
healthiest balance sheets among its peers, which helps it to
capitalize on investment opportunities with the option to make
strategic acquisitions.
While all crude-focused stocks 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. In particular, we suggest
exposure to small-cap, undervalued E&P players like
Callon Petroleum Co. (CPE), Miller Energy
Resources Inc. (MILL) and Abraxas Petroleum
Corp. (AXAS), which enjoy the benefits of crude oil price
leverage.
One may also capitalize on this opportunity with the related
business sector of energy equipment service providers. Our top pick
in this space is Cameron International Corp.
(CAM). This oil drilling equipment maker boasts of a diversified
product portfolio, specialty service capabilities and proprietary
technological expertise. Other positives for Cameron include a
strong backlog position, growing international operations and a
favorable outlook for subsea activity levels.
Further, we remain optimistic on the near-term prospects of
Baker Hughes Inc. (BHI). The oilfield services
behemoth during its recent first quarter outperformance pointed
towards an improving North American market, coupled with strength
in the Middle East and Asia. Baker Hughes also remains positive
about stepped-up activity in the U.S. Gulf of Mexico.
Within the contract drilling group, we like Helmerich &
Payne Inc. (HP). Supported by a superior and diversified
drilling fleet, together with a healthy financial profile, we
expect the company to sustain its profitability over the
foreseeable future. We believe Helmerich & Payne’s
technologically-advanced FlexRigs will continue to benefit from an
upswing in U.S. land drilling activity and the shift to complex
onshore plays that require highly intensive solutions.
Canada's biggest energy firm and the largest oil sands outfit
Suncor Energy Inc. (SU) is also worth a look. We
like the company’s impressive portfolio of growth opportunities,
unique asset base and high return potential in the long run. Suncor
has significant oil sands and conventional production platform,
huge long-lived oil-sands reserves and a robust downstream
portfolio. The company's asset base includes substantial
conventional reserves and production at offshore Eastern Canada and
in the North Sea, which generate strong margins and should provide
free cash flow to fund future oil sands expansion.
Finally, despite the uncertain natural gas fundamentals and the
understandable reluctance on the investors’ part to dip their feet
into these stocks, we would advocate buying Range Resources
Corp. (RRC). It has been among the better performing
S&P stocks since the start of 2014, gaining 12% during the
period. Most of the gains have been driven by Range Resources’
exposure to the high-return Marcellus Shale play, as well as the
company’s above-average production growth.
WEAKNESSES
Fears of an economic slowdown in China have prompted us to be
bearish on the country’s main integrated energy players,
PetroChina Company Ltd. (PTR) and
Sinopec (SNP). Both remain exposed to the risk of
China’s stuttering economic growth that may significantly decrease
its demand for oil, natural gas and chemicals.
We are also skeptical on Italian energy company Eni
SpA (E). The integrated player, with a large presence in
Libya, has seen its total production fluctuate in recent times,
primarily due to operational disturbances at several fields in the
North African nation. Additionally, Eni's upstream portfolio
carries greater political risk than its peers, since it has the
highest exposure to the OPEC countries. The Rome-based company has
also been mitigated by a weak macroeconomic scenario in Italy and
Europe that is likely to affect its performances going forward.
We see little reason for investors to own engineering and
construction firm McDermott International Inc.
(MDR). Following McDermott’s recent stock offering and
disappointing first quarter operational update, we have become
bearish about the firm’s near-term prospects. The company’s steep
operating costs, an erratic earnings trend over the last few
quarters and lack of clarity about some of the big projects add to
the negative sentiment.
Based upon the number of near-term challenges, we remain
pessimistic on the near-term prospects of Talisman Energy
Inc. (TLM). In particular, we expect investor sentiment
towards the Canadian energy explorer to remain lukewarm,
considering its maintenance/production issues and operational
problems. We further believe that Talisman’s policy shift towards
the promising North American oil and liquids rich areas will take
some time to bear results.
Contract drilling services provider Rowan Companies
plc (RDC) is another company we would like to avoid for
the time being. The volatility in the macro backdrop along with
operational hindrances raises concerns. Furthermore, the company
expects its contract drilling expenses to increase by 5% to 7% in
2014. Rowan also expects this year’s operating costs to rise by 10%
to 11% from 2013 levels.
Lastly, we recommend avoiding legacy offshore driller like
Transocean Ltd. (RIG). The most pressing concern
for the group, at least in the short-term, will be oversupply in
the rig market. With multinational energy biggies looking to reign
in their skyrocketing capital expenses, the offshore drilling space
is likely to see intense competition, as multiple firms run after a
single contract.
This excess capacity, in turn, could lead to lower utilization
or dayrates. As the sector looks set to enter a cyclical downturn
and struggle with idled rigs, we do not see an immediate rebound in
the sentiment and expect more punishing times ahead for the likes
of Transocean.
ABRAXAS PETE/NV (AXAS): Free Stock Analysis Report
BAKER-HUGHES (BHI): Free Stock Analysis Report
CAMERON INTL (CAM): Free Stock Analysis Report
CALLON PETE-DEL (CPE): Free Stock Analysis Report
CHEVRON CORP (CVX): Free Stock Analysis Report
ENI SPA-ADR (E): Free Stock Analysis Report
HELMERICH&PAYNE (HP): Free Stock Analysis Report
MCDERMOTT INTL (MDR): Free Stock Analysis Report
MILLER ENERGY (MILL): Free Stock Analysis Report
PETROCHINA ADR (PTR): Free Stock Analysis Report
ROWAN COS PLC (RDC): Free Stock Analysis Report
TRANSOCEAN LTD (RIG): Free Stock Analysis Report
RANGE RESOURCES (RRC): Free Stock Analysis Report
CHINA PETRO&CHM (SNP): Free Stock Analysis Report
SUNCOR ENERGY (SU): Free Stock Analysis Report
TALISMAN ENERGY (TLM): Free Stock Analysis Report
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