Expectations of an improving economy and bullish supply data have
strengthened oil prices to around $100 per barrel. Crude's recent
run has been spurred by the Federal Reserve's measured Taper
announcement. The central bank -- asserting that the U.S. economy
was strong enough -- stated that it will reduce bond repurchases by
$10 billion, bringing its monetary stimulus to $75 billion a month
from Jan 2014.
This has fueled hopes for robust fuel and energy demand in the
world's biggest oil consumer. The bullish momentum was further
propelled by positive revision to third quarter GDP numbers and
continued decline in U.S. supplies.
Partly offsetting this favorable view has been a spike in domestic
production -- now at their highest levels since 1988 -- and
suggestions of increase in Libyan oil exports following months of
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, the Middle East, Central and South America that continue to
expand at a healthy rate.
According to the Energy Information Administration (EIA), which
provides official energy statistics from the U.S. Government, world
crude consumption grew by an estimated 1.1 million barrels per day
in 2013 to a record-high level of 90.3 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, EIA's latest report assumes that
world supply is also likely to go up by 1.2 million barrels per day
In our view, crude prices in the first half of 2014 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.
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 $1.82 per million Btu (MMBtu) during
late April 2012 (referring to spot prices at the Henry Hub, the
benchmark supply point in Louisiana).
Investors continue to focus on temperature patterns to understand
the fuel's economic dynamics. As it is, natural gas fundamentals
look uninspiring with supplies remaining ample in the face of
underwhelming demand. In fact, it is expected to take many years
for the commodity's demand to match supply in the face of newer
Despite these issues, natural gas rallied to a two-year high
recently on the back of persistent decreases in natural gas
supplies and forecasts of freezing cold weather conditions, which
boost natural gas demand for space heating by
ZACKS INDUSTRY RANK
Oil/Energy is one the 16 broad Zacks sectors within the Zacks
Industry classification. We rank all of the more than 260
industries in the 16 Zacks sectors based on the earnings outlook
for the constituent companies in each industry. To learn more
Zacks Industry Rank
The way to look at the complete list of 260+ industries is that the
outlook for the top one-third of the list (Zacks Industry Rank of
#88 and lower) is positive, the middle 1/3rd or industries with
Zacks Industry Rank between #89 and #176 is neutral while the
outlook for the bottom one-third (Zacks Industry Rank #177 and
higher) is negative.
The oil/energy industry is further sub-divided into the following
industries at the expanded level: Oil - U.S. Integrated, Oil and
Gas Drilling, Oil - U.S. Exploration and Production, Oil/Gas
Production Pipeline MLP, 'Oilfield Services, Oil - International
Integrated, Oil - Production/Pipeline, Oilfield Machineries and
Equipment, Oil-C$ Integrated, and Oil Refining and Marketing.
The 'Oil and Gas Drilling' is the best placed among them with its
Zacks Industry Rank #29, comfortably placing it into the top 1/3rd
of the 260+ industry groups, where it is joined by the Oil Refining
and Marketing ' with a Zacks Industry Rank #74.
The 'Oil/Gas Production Pipeline MLP' -- with a Zacks Industry Rank
#96 -- moves out of the top 1/3rd and into the middle 1/3rd. The
'Oil - U.S. Exploration and Production' also lie in the middle
1/3rd, with Zacks Industry Rank #149.
However, all the other sub-sectors -- Oil - Production/Pipeline,
Oil-C$ Integrated, Oilfield Services, Oil - International
Integrated, Oil - U.S. Integrated, and Oilfield Machineries and
Equipment -- are featuring in the bottom one-third of all Zacks
industries with respective Zacks Industry Ranks of #181, #191,
#206, #208, #214 and #237, respectively.
Looking at the exact location of these industries, one could say
that the general outlook for the oil/energy space as a whole is
As far as overall results of the Oil/Energy sector is concerned, it
displays an encouraging trend. While earnings fell 8.4% in the
third quarter of 2013, it improved from the 11.2% drop witnessed in
the previous quarter. What's more, there was a marked enhancement
in revenue performance, which was up 2.8% in the September quarter
as against a decline of 5.4% in the second quarter.
The sector had a mixed performance in terms of beat ratios
(percentage of companies coming out with positive surprises). The
earnings "beat ratio" was an impressive 62.2%, but the revenue
"beat ratio" was underwhelming, at 37.8%.
For more information about earnings for this sector and others,
please read our '
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
). 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 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
Harvest Natural Resources Inc.
Abraxas Petroleum Corp.
), 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
). This offshore drilling equipment maker boasts of highly
engineered drilling and production equipment for deepwater
severe-service applications and harsh environmental conditions.
Further, we remain optimistic on the near-term prospects of
). The oilfield services behemoth -- among the top three players in
each of its product/service categories -- is enjoying strong demand
for its services in international markets and expects the trend to
continue in the coming quarters. The company's inexpensive
valuation and a favorable DOJ verdict over its role in the Macondo
oil spill lend additional support.
Within the contract drilling group, we like
Helmerich & Payne Inc.
). 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'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
Offshore drilling giant
) is also a top pick. With its technologically-advanced and
versatile offshore drilling fleet, strong backlog and considerable
pricing power, the company offers an unmatched level of earnings
and cash flow visibility. The recent dividend approval and the
settlement of a host of civil/criminal claims associated with the
Deepwater Horizon incident have also eased the overhang on the
Finally, buoyed by the favorable trends in the refining sector, we
are more optimistic on the industry than we were a few months ago.
After going through a bumpy ride for much of 2013, the sector has
started to look up -- and it's mainly to do with the 'oil spread,'
the difference between the WTI price and its global counterpart,
With refiners being buyers of WTI, while selling their products
based on Brent, the wider the so-called 'Brent-WTI spread,' the
better it is for the sector components. With current oil spread at
more than $10 per barrel, refinery stocks are set to benefit.
Against this backdrop, we are particularly bullish on
Valero Energy Corp.
Western Refining Inc.
We are bearish on Europe's largest oil company
Royal Dutch Shell plc
). The integrated player is particularly susceptible to its high
exposure to the downstream business, as well as its major natural
gas focus and lofty capital spending.
We are also skeptical on Italian energy company
). 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 domestic upstream
Noble Energy Inc.
), particularly due to the flood in Northern Colorado, which is
expected to negatively impact production in fourth quarter. In
addition, Noble's international business operations are exposed to
political and economic risks rife in West Africa and the Middle
Based upon the number of near-term challenges, we remain
pessimistic on the near-term prospects of
National Oilwell Varco Inc.
). With markets remaining competitive and pricing likely to be
soft, the energy equipment maker's margins are expected to suffer
in the next few quarters. Recent weakness in the North American
onshore drilling environment has also been a negative. Furthermore,
we expect shares to remain depressed until it increases its sub-par
Land drilling contractor
Nabors Industries Ltd.
) is another company we would like to avoid for the time being,
mainly due to headwinds in the pressure pumping market on the back
of collapsing prices and lower utilization. The recent weakness in
the North American onshore rig count has also been a negative. As
usual, we remain concerned about weak natural gas fundamentals,
which are likely to limit the company's ability to generate
positive earnings surprises. Nabors' fairly debt-heavy balance
sheet also remains an issue.
Lastly, we recommend avoiding contract drilling services provider
Rowan Companies plc
). 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 2013. Rowan
also expects 2014 operating costs to rise by 10% to 11% from 2013
ABRAXAS PETE/NV (AXAS): Free Stock Analysis
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HELMERICH&PAYNE (HP): Free Stock Analysis
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NABORS IND (NBR): Free Stock Analysis Report
NATL OILWELL VR (NOV): Free Stock Analysis
ROWAN COS PLC (RDC): Free Stock Analysis Report
ROYAL DTCH SH-A (RDS.A): Free Stock Analysis
TRANSOCEAN LTD (RIG): Free Stock Analysis
VALERO ENERGY (VLO): Free Stock Analysis Report
WESTERN REFING (WNR): Free Stock Analysis
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