The ongoing Syrian conflict -- particularly whether or not the U.S.
will intervene -- a tightening global supply picture in view of the
output loss from disruptions in Libya, together with positive
momentum in the domestic manufacturing sector and bullish data from
the Chinese economy have strengthened oil prices to 2-year highs of
around $110 per barrel. Partly offsetting this favorable view has
been a spike in U.S. production -- now at their highest levels
since 1989 -- and suggestions that the U.S. may taper its monetary
stimulus later this year.
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 0.7 million barrels per day
in 2012 to a record-high level of 89.0 million barrels per day.
The agency, in its most recent Short-Term Energy Outlook, said that
it expects global oil demand growth by another 1.1 million barrels
per day in 2013 and by a further 1.2 million barrels per day in
2014. Importantly, EIA's latest report assumes that world supply is
likely to go up by 0.8 million barrels per day this year and by 1.2
million barrels per day in 2014.
In our view, crude prices in the final few months of 2013 are
likely to exhibit a sideways-to-bearish trend, trading in the
$100-$105 per barrel range. As tension over the U.S. military
intervention over Syria show signs of settling down, 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).
However, things started to look up in 2013. This year, cold winter
weather across most parts of the country boosted natural gas demand
for space heating by residential/commercial consumers. This,
coupled with flat production volumes, meant that the inventory
overhang was gone, thereby driving commodity prices to around $4.40
per MMBtu in Apr -- the highest in 21 months.
During the last few weeks, though, natural gas demand has gone
through a relatively lean period, as mild weather -- from July
through mid-August -- prevailed over the country, leading to tepid
electricity draws to run air conditioners. This led to a slide in
the commodity's price. In fact, healthy injections over last few
weeks, plus strong production, have meant that supplies have
overturned the deficit over the five-year average.
With more moderate weather expected during the next few weeks,
leading to reduced power demand, natural gas prices may experience
another downward curve. This, in turn, is expected to pull down
natural gas producers, particularly small ones.
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
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 - Integrated, and Oil Refining and Marketing.
The 'Oil - U.S. Integrated' is the best placed among them with its
Zacks Industry Rank #36, comfortably placing it into the top 1/3rd
of the 260+ industry groups, where it is joined by the 'Oil - U.S.
Exploration and Production' with a Zacks Industry Rank #84.
The 'Oil and Gas Drilling' - with a Zacks Industry Rank #99 - just
moves out of the top 1/3rd and into the middle 1/3rd. The 'Oil -
International Integrated' also lies in the middle 1/3rd with Zacks
Industry Rank #119. The 'Oil/Gas Production Pipeline MLP' and
'Oilfield Services' barely makes into the middle 1/3rd with a Zacks
Industry Rank #161 and #166, respectively.
However, all the other sub-sectors -- Oilfield Machineries and
Equipment, Oil - Production/Pipeline, Oil - Integrated, and Oil
Refining and Marketing -- are featuring in the bottom one-third of
all Zacks industries with respective Zacks Industry Ranks of #202,
#202, #233 and #251, 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 a bearish trend with earnings falling 12.7% in the second
quarter of 2013, weakening sharply from the 1.0% drop witnessed in
the previous quarter. However, there was a marginal improvement in
revenue performance, which was down 5.6% in the June quarter as
against a decline of 6.3% in the first quarter.
Second quarter earnings across all 16 sectors covered by Zacks
increased 2.5%, most of it coming from the Finance sector. Should
we exclude Finance, earnings would be down 2.9% year over year,
with one of the underperformers being the Oil/Energy sector.
In particular, the Oil/Energy sector has suffered from weak results
Exxon Mobil Corp.
), which has a significant weight within the sector. Nevertheless,
the sector had a decent performance in terms of beat ratios
(percentage of companies coming out with positive surprises). The
earnings "beat ratio" was 54.8%, while the revenue "beat ratio" was
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
Matador Resources Co.
Memorial Production Partners L.P.
), which enjoy the benefits of crude oil price leverage.
The current oil price environment should also benefit producers,
particularly those international players having attractive growth
opportunities in their home markets. One such standout name is
PetroChina Company Ltd.
), which remains well-placed to benefit from the country's growing
appetite for energy and the turnaround in commodity prices. We are
also encouraged by the natural gas price reform that is expected to
boost PetroChina's margins.
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.
) is also a top pick. CNOOC remains well-placed to benefit from the
country's growing appetite for energy and the turnaround in
commodity prices. In particular, the company enjoys a monopoly on
exploration activities in China's very prospective offshore region
in addition to having a growing presence in the country's natural
gas and liquefied natural gas (LNG) infrastructure.
The recent acquisition of Canadian energy producer Nexen Inc. will
further improve CNOOC's growth profile by augmenting proven
reserves by 30%, while helping it to vastly expand its holdings in
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.
Cabot Oil & Gas Corp.
). Both of them have been among the better performing S&P
stocks since the start of 2013, gaining 25% and 55% during the
period, respectively. Most of the gains have been driven by their
exposure to the high-return Marcellus Shale play, as well as their
above-average production growth.
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 bearish on Brazil's state-run energy giant
Petroleo Brasileiro S.A.
), or Petrobras S.A. Following the company's lower-than-expected
second quarter showing, we see little reason for investors to own
the stock. The Rio de Janeiro-headquartered group remains plagued
by several issues that include decreased liquids realizations, weak
production, huge investment requirements and the possibility of
heightened state interference.
Energy-focused engineering and construction firm
McDermott International Inc.
) is another company we would like to avoid for the time being,
mainly due to its erratic earnings trend over the last few quarters
and a disappointing outlook for 2013. Apart from having to deal
with steeper operating costs, McDermott has already hinted that its
top line will suffer next year due to uncertainty regarding the
timing of big awards.
One sector that has underperformed the rest of the energy industry
is 'refining and marketing. With refiners being buyers of crude --
whose price has seen a steep climb recently -- their profitability
has been negatively impacted due to a rise in the input cost and
lower crack spreads. Against this backdrop, we are particularly
Marathon Petroleum Corp.
CNOOC LTD ADR (CEO): Free Stock Analysis Report
CABOT OIL & GAS (COG): Free Stock Analysis
CHEVRON CORP (CVX): Free Stock Analysis Report
MCDERMOTT INTL (MDR): Free Stock Analysis
MEMORIAL PRODUC (MEMP): Free Stock Analysis
MARATHON PETROL (MPC): Free Stock Analysis
MATADOR RESOURC (MTDR): Free Stock Analysis
PETROBRAS-ADR C (PBR): Free Stock Analysis
PETROCHINA ADR (PTR): Free Stock Analysis
ROYAL DTCH SH-A (RDS.A): Free Stock Analysis
RANGE RESOURCES (RRC): Free Stock Analysis
EXXON MOBIL CRP (XOM): Free Stock Analysis
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