These Energy Stocks Will Benefit The Most From $70/Barrel Oil

Stock SectorMay 7, 20187min9

I’ve written past columns for Forbes delineating the winners from $50/barrel oil, $60/barrel oil and so on. As oil hits — and holds —$70/barrel today, the list of winners is easier to identify: all energy stocks. It’s really that simple. That said, I don’t want to sound like one of those faux-fund managers who goes on CNBC and rattles off a list of 20 stocks “you must own.”  As an active fund manager, I know that the secret to outperforming benchmarks is conviction.  Picking the right stocks to own/not own and owning those stocks in larger/smaller proportions in your portfolio versus their individual benchmark weightings.

WELD COUNTY, CO – SEPTEMBER 14: An oil pump or pump jack in a field with energy development still going strong on Thursday, September 14, 2016. (Photo by Steve Nehf/The Denver Post via Getty Images)

So, while I certainly wouldn’t be selling any energy stock into this buoyant market and with President Trump’s decision on the fate of the Iran deal due by May 12, I am not buying all energy stocks in proportion to their ETF weightings, nor am I buying the ETFs themselves like commodity-based USO or sector-based XLE.  No, I’m a stock picker, and when picking among energy stocks, I follow the following rules of thumb.

Own the stocks, not the commodity. You want to own shares of the commodity producers because those companies can take the proceeds from higher commodity prices and invest them in projects that produce returns in excess of their cost of capital.  Sorry if that was too pedantic, but this is also true of other commodities such as gold. When the commodity price is in an upswing, you want to capture the upside from the stocks. A company like Diamondback Energy can take proceeds from this updraft and produce sky-high internal rates of return.  A barrel of oil is, well, a barrel of oil. It’s an important difference.

Do a little research and identify specific stocks that benefit from megatrends. I noted above that I am not selling energy stocks, but obviously capital is a scarce good.  I need to prioritize the stocks that have the most upside for my clients’ accounts.  Leave “a rising tide lifts all boats” to Hallmark and do a few minutes of research to create a decision tree.

What’s hot: black oil.  Natural gas prices are still depressed, so companies like Diamondback and Concho that produce much more oil than natural gas are more attractive than “gassier” plays such as Chesapeake.

The Permian. This area is red-hot now and the level of activity is high, as shown by the Baker Hughes rig count numbers, but still well below 2014 peak levels.  So you should own stocks of companies that are exposed to the Permian, like Diamondback and Concho, which will be even more exposed to the Midland Basin when its acquisition of RSP Permian closes. Companies that operate in other plays such as South Texas (the Eagle Ford) Oklahoma (STACK) and in the Gulf of Mexico are somewhat less attractive,  even as the commodity price increases.

Brent crude. It’s also worth noting that the spread between the non-U.S. benchmark (Brent) and the U.S. benchmark (West Texas Intermediate) remains elevated, at about $5/bbl.  So, if you had to choose between BP and Royal Dutch Shell and Exxon and Chevron here, I would go with the Euros.

Zig when others zag. This is my guiding principle. A great way to quantify this is to look at the short interest tables in the Wall Street Journal. According to the most recent data, the top 25 most shorted names in the NYSE include Chesapeake (#3,) Weatherford (#4,) Ensco (#13,) McDermott (#16,) Transocean (#20,) and Denbury Resources (#25.)  As I said above, Chesapeake is less attractive at the margin because of its gassiness, but the funds shorting CHK shares are the same ones (I know managers at many of these funds) that have been obliterated in their shorts of Diamondback, Concho, Pioneer Resources and also the refiners.  I just don’t know how these funds stay in business but they are going to get hammered again as oil prices continue to rise this summer.

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