The imminent lifting of the four-decade old ban on U.S. oil exports has suddenly put the domestic energy players in the spotlight. The move was expedited as part of a broader spending plan and tax bill that's currently making waves in the Congress, which is under constant pressure from the Republican majority to lift the ban. What makes it more interesting is that Democrats are only asking for equal concessions for the renewable energy space.
This we feel would prove to be another let down for the beleaguered spot. The market’s primary concern was that the commodity’s steep decline reflected a bigger-than-expected drop in demand as a result of decelerating global economic growth. Questions about China’s economic outlook and weakness in Brazil, Russia and many other emerging markets stem from these growth worries.
As a result, oil prices are still displaying weakness in the broader global commodity complex. Oil prices have been trickling down since last Friday, when the International Energy Administration (IEA) announced that abundant supply of oil will persist till next year even though demand for oil continues to decline. Price of WTI crude oil dropped 3.2% to $35.62 a barrel on Friday. Fate obviously hasn’t been kind to the space as evident by the $36 per barrel mark that WTI is currently hovering around.
This put the spotlight on the sector’s financial strength — in particular on its ability to continue servicing debt and paying out dividends. Recent dividend cuts from Kinder Morgan Inc. KMI and Encana Corp. ECA as a way to conserve cash confirm the problems in the space.
Local Oil Remains Cheaper
To add to the woes of U.S. producers, the recent shell boom has made supply ample but the export ban forces them to dish out crude at a lower rate than the international market. Advocates of the ban lift point out that the geopolitical scenario was entirely different four decades ago. At that time, the ban was enforced to protect the nation from the Organization of the Petroleum Exporting Countries (OPEC) oil embargo.
Owing to limited local supplies, the U.S. economy had then witnessed sky high crude prices which severely damaged the economy. As such, we have witnessed a purgatory of widening spread between Brent crude prices and WTI to affect the health of the U.S. economy.
Energy Information Administration (EIA) in its December Short-Term Energy Outlook forecast that U.S. crude oil production declined by about 60,000 barrels per day in November from October. Crude oil production is forecast to decrease through the third quarter of 2016 before growth resumes in late 2016.
Given the present scenario, lifting the four-decade old ban on U.S. oil exports makes more sense. This mood is now echoing from the divergent corners of Capitol Hill. Initiation of exports would greatly help the beleaguered books of independent exploration and production companies.
Capitol Hill has seen intense lobbying by industry majors for lifting the ban. These include CEO Ryan Lance of ConocoPhillips COP, Harold Hamm of Continental Resources Inc. CLR, John Hess of Hess Corp. HES and Scott Sheffield of Pioneer Natural Resources Co. PXD.
If the present trend of patronage continues, the House will likely vote in favor of lifting the ban. This would certainly bring a fresh lease of life to the energy space, so long embroiled in apprehensions pertaining to the Chinese economy, hiccups over the Fed rate hike, a stronger dollar and near-record production from OPEC (mainly in Saudi Arabia and Iraq).
The Road Ahead for Energy Players
The move toward lifting of the ban has spread fears that condensate export would be extended to more U.S. companies, leading to a tight oil market. This would narrow the gap between the U.S. and international oil prices thereby weakening refiners’ margins, as producers will sell oil at international prices. As such, international prices will likely fall and U.S. prices would rise.
A prolonged period of low oil prices has eventually lent quality upstream assets some cheap valuations. Therefore, we would like to draw investors’ attention to the neglected upstream space, where most players are trading below par. Smart investors might see this as a window of opportunity.
As such, with oil hovering around the $36-a-barrel level, investors with an appetite for gains should pick the upstream gems out of the rubble with the help of the time-tested Zacks Rank Methodology which arranges stocks from #1 (Strong Buy) to #5 (Strong Sell).
Laggards
We would advise investors to steer clear of some companies with significant downstream operations like Enbridge Inc. ENB, MPLX LP MPLX, NuStar GP Holdings, LLC NSH, Ultrapar Holdings Inc. UGP and SemGroup Corp. SEMG. These could see some near-term selloff.
Winners
From the passage of the export bill, the biggest gainers would be the West Texas Intermediate (WTI) exposed upstream players. Investors can start accumulating some well-placed players in the upstream space like Contango Oil & Gas Co. MCF, Chesapeake Energy Corp. CHK, Cobalt International Energy, Inc. CIE, Comstock Resources Inc. CRK and Devon Energy Corp. DVN. Each of these stocks carries either a Zacks Rank #1 (Strong Buy) or Zacks Rank #2 (Buy).
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