Crude oil prices, which are already moving south, may be troubled further by a potential Federal rate hike. Renewed rate hike jitters come right after domestic GDP recovery emerged out in the second quarter.
Per the Bureau of Economic Analysis, output in the U.S. increased at an annual rate of 4% in the second quarter. The upside came mainly from growing personal consumption expenditure, private inventory investment, exports, non-residential fixed investment, state-cum-local government spending and residential fixed investment.
Stronger Economy, Weaker Oil
Signs of recovery in the U.S. economy, however, bring their fair share of woes for oil. This is due to the fact that a stronger dollar raises the price of crude as a commodity in the international market and limits its demand. Also, the proposed hike in Federal interest rates to pull up the greenback, has resulted in a more pronounced flight toward U.S. government bonds and bond proxies.
In the country’s oil market, this flurry of bonds has sparked concerns about the future direction of crude price and threatens investor sentiment. Concerns over a spike in U.S. labor costs and a credit default by Argentina pose added concerns for investors.
What’s Biting WTI Prices?
There couldn’t be a worse time for crude prices. Last week, the West Texas Intermediate (WTI) crude mostly confined itself below the $100 mark. The closure of CVR Refining, LP’s (CVRR) refinery in Coffeyville, KS was a major culprit. Lower demand and a stronger greenback are also pushing WTI prices to the cheap levels of March. Moreover, lower gasoline crack spreads precipitated by higher inventory levels is also putting downward pressure on oil prices. Market pessimism indicates that if the current trend continues, prices might fall to around $90 barrel in the near term.
Where to Put My Dollars
This puts investors at a fix as to where to look for value. After all, the fortunes of a number of sectors are invariably tied to oil. In such a volatile market, risk-averse investors may scurry toward Treasury bills, notes and securities issued by government agencies. However, with the Fed steadily progressing on tapering front making the basis differential between five and 30-year bond yields wider, we see little incentive for investors to pour their money into these assets now.
Final Destination
Lower demand for crude will create pressure on the price of the commodity and in turn greater volatility in share prices.
This is due to the fact that investor sentiment for most oil plays is determined by earnings and valuation multiples. As such, investors should bet on asset-backed oil plays or exploration and production (E&P) companies that the market is yet to fully price in since forward multiples are lower than prior upcycles.
Choosing the Best of the Lot
Picking a stock from an entire industry could be a herculean task. Here we will list 3 stocks that may witness an upside due to these factors. These stocks have witnessed upward estimate revisions recently. Moreover, share prices for each of these stocks have also improved considerably. These stocks carry either a Zacks Rank #1 (Strong Buy) or #2 (Buy).
To further simplify things, we have found three stocks matching this criterion. These stocks are enjoying a nice run in the market, with prices rallying over 15% in the last three months.
Clayton Williams Energy, Inc. (CWEI)
Midland, TX-headquartered Clayton Williams Energy is engaged in the exploration and production of oil and natural gas primarily in its home state, Louisiana, and New Mexico. As of 2013 end, the company had 70.0 million barrels of oil equivalents (MMBOE) of proved reserves, which were 82% oil and 55% proved developed. It also added proved reserves of 27.7 MMBOE in 2012, resulting in a reserve replacement of 526%.
The stock holds a Zacks Rank #1 and earnings for the current year are expected to rise 61.1%.
Estimate Revision: Clayton Williams has seen only positive revisions in the last 60 days for both the ongoing quarter and current year estimates. Quarterly earnings consensus has improved from $1.44 a share to $1.46. Yearly earnings consensus has also improved from $4.99 a share to $5.32.
Share Price: The stock has gained 2.14% over the last four weeks.
Whiting Petroleum Corp. (WLL)
Whiting Petroleum Corporation acquires, exploits, develops and explores for crude oil, natural gas and natural gas liquids primarily in the Permian Basin, Rocky Mountains, Mid-Continent, Gulf Coast and Michigan regions of the U.S. The company has a long-term earnings expectation of 15.6%.
Although there are some concerns over growth rates, estimates have largely been moving north, especially for the upcoming quarter. The firm has a track of earnings outperformance, and the most recent estimate suggests that we could see another beat this quarter from this Delaware corporation.
The stock holds a Zacks Rank #2 and earnings for the current year are expected to rise 25.6%.
Estimate Revision: Whiting Petroleum has seen 15 positive revisions in the last 60 days both for the ongoing quarter and the current year estimates. As a result, quarterly earnings consensus has improved from $1.23 a share to $1.42. Yearly earnings consensus has similarly improved from $4.65 a share to $5.08.
Share Price: The stock has gained 9.5% over the last four weeks.
EOG Resources Inc. (EOG)
Houston, TX-based EOG Resources Inc. is a major independent oil and gas exploration and production company, with operations in the U.S., Canada, offshore Trinidad, and the U.K. North Sea. As of Dec 31, 2013, EOG’s total estimated net proved reserves were 2,119 million barrels of oil equivalent (MMBoe). Approximately 94% of these reserves were located in the United States, 4% were in Trinidad, 1% was in Canada, and 1% in other international locations. Total company net proved liquids reserves increased 25%, year over year, and comprised 60% of the company’s total net proved reserves at the year end.
The stock holds a Zacks Rank #2 and earnings for the current year are expected to rise 38.1%.
Estimate Revision: EOG Resources has seen 11 positive revisions in the last 60 days for the ongoing quarter and 14 positive revisions for current year estimates. Quarterly earnings consensus has improved from $1.33 a share to $1.43. Yearly earnings consensus has also improved from $5.33 cents a share to $5.68.
Share Price: The stock has gained a third of its value year to date.
Bottom Line
The economics of oil and gas supply and demand is the fundamental driver of the E&P industry. Previous strength in commodity prices enabled E&P stocks to generate good returns year to date in 2014. This is reflected in the SIG Oil Exploration & Production Index which has traded 9.2% higher year to date. As such, material share price rises will be rare going forward barring some outperformers backed by a solid Zacks Rank and positive earnings revisions. Investors looking to veer from the Fed rate mayhem this summer should be on the lookout for these.
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