Record domestic production and the easing of geopolitical fears
have combined to keep
below the major psychological threshold of $100 per barrel.
In particular, a spike in U.S. output -- now at their highest
levels since 1986 -- has ballooned crude inventories to around 370
million barrels, thereby creating a supply glut. The commodity's
recent lack of momentum also stems from perceptions of easing
tensions over Iraqi oil exports. Till now, the militant uprising is
limited to the northern part of the country, while Iraq's
production region in the south remains largely unscathed. Concerns
about the European economy and the resumption of output from
Libya's largest oilfield have been further weighing on sentiments.
Partly offsetting this unfavorable view has been a host of largely
positive economic data, pointing towards improvement in the U.S.
labor market. This has prompted hopes for robust fuel and energy
demand in the world's biggest oil consumer. The bullish momentum
has been aided by the Federal Reserve's measured Taper reduction.
The central bank -- asserting that the U.S. economy was strong
enough -- trimmed bond repurchases to $25 billion a month in July,
substantially down from the peak of $85 billion.
In the medium-to-long term, while the Western economies exhibit
sluggish growth prospects, global oil demand is expected to get a
boost from sustained strength in China, which continue to expand at
a healthy rate despite some moderation.
According to the Energy Information Administration (EIA), which
provides official energy statistics from the U.S. Government, world
crude consumption grew by an estimated 1.3 million barrels per day
in 2013 to a record-high level of 90.4 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 2014. But importantly, the EIA's latest report assumes that
world supply is likely to outpace consumption growth and go up by
1.5 million barrels per day in 2014.
In our view, crude prices in the next few months are likely to
exhibit a sideways-to-bearish trend, mostly 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 $1.82 per million Btu (MMBtu) during
late April 2012 (referring to spot prices at the Henry Hub, the
benchmark supply point in Louisiana).
However, things have started to look up somewhat following a frigid
winter that saw the heating fuels' demand take off. This pushed
commodity prices to its highest level in 5 years earlier this year.
But with recent natural gas stock builds continuing to outpace the
historical norms on the back of strength in summer production and
mild weather, the commodity's near-term fundamentals remain rather
lukewarm, at least till the next heating season starting November.
ZACKS INDUSTRY RANK
Oil/Energy is one the 16 broad Zacks sectors within the Zacks
Industry classification. We rank all of the more than 260
industries in the 16 Zacks sectors based on the earnings outlook
for the constituent companies in each industry. To learn more
About Zacks Industry Rank
The way to look at the complete list of 260+ industries is that the
outlook for the top one-third of the list (Zacks Industry Rank of
#88 and lower) is positive, the middle 1/3rd or industries with
Zacks Industry Rank between #89 and #176 is neutral while the
outlook for the bottom one-third (Zacks Industry Rank #177 and
higher) is negative.
The oil/energy industry is further sub-divided into the following
industries at the expanded level: Oil - U.S. Integrated, Oil and
Gas Drilling, Oil - U.S. Exploration and Production, Oil/Gas
Production Pipeline MLP, Oilfield Services, Oil - International
Integrated, Oil - Production/Pipeline, Oilfield Machineries and
Equipment, Oil-C$ Integrated, and Oil Refining and Marketing.
The 'Oil - U.S. Integrated' is the best placed among them with its
Zacks Industry Rank #18, comfortably placing it into the top 1/3rd
of the 260+ industry groups, where it is joined by the 'Oilfield
Machineries and Equipment' and 'Oil - International Integrated'
with respective Zacks Industry Ranks #45 and #79.
The 'Oil and Gas Drilling' -- with a Zacks Industry Rank #89 --
moves just out of the top 1/3rd and into the middle 1/3rd. The 'Oil
- U.S. Exploration and Production,' 'Oil/Gas Production Pipeline
MLP' and 'Oil - Production/Pipeline,' with Zacks Industry Ranks of
#91, #97 and #104, respectively.
However, all the other sub-sectors - Oil Refining and Marketing,
Oilfield Services, and Oil-C$ Integrated - are featuring in the
bottom one-third of all Zacks industries with respective Zacks
Industry Ranks of #209, #218 and #221.
Looking at the exact location of these industries, one could say
that the general outlook for the oil/energy space as a whole is
leaning toward 'Neutral' to 'Positive.'
A look back at the just-concluded Q2 earnings season reflects that
as far as overall results of the Oil/Energy sector is concerned, it
displays a bullish trend. Crude prices rose to their highest level
in nine months during this period, as tensions over Iraq continued
to feed supply concerns in the Middle East.
During the June quarter, earnings rose 12.2% year over year, a
substantial improvement from the 1.6% decrease witnessed in the
previous quarter. There was some progress on the revenue front too,
which was up 2.1% in the second quarter as against a gain of just
0.8% in the first quarter.
The sector has also been encouraging in terms of beat ratios
(percentage of companies coming out with positive surprises). While
the earnings "beat ratio" was good at 55.6%, the revenue "beat
ratio" was even more impressive, at 64.4%.
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 Chevron Corp. (
). 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 its 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 $90+ 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 Emerald Oil Inc. (
) and Jones Energy Inc. (
), 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 Cameron International Corp. (
). The oil drilling equipment maker boasts of a diversified product
portfolio, specialty service capabilities and proprietary
technological expertise. Other positives for Cameron include a
strong backlog position, growing international operations and a
favorable outlook for subsea activity levels.
Further, we remain optimistic on the near-term prospects of
Weatherford International plc (
). Going forward, there are plenty of positives for the oilfield
services behemoth, including its leading position in the global
market, its broad and technologically complex product/service
offerings, and its growing presence in the relatively stable
Eastern Hemisphere. The company is well positioned to take
advantage of the multi-year expansion in the international upstream
segment. The process is ongoing and is likely to gather momentum
Within the contract drilling group, we like Nabors Industries Ltd.
) and Patterson-UTI Energy Inc. (
). Supported by their large and high-quality drilling fleet of
rigs, together with considerable exposure to the U.S. shale
bonanza, we expect the companies to sustain profitability over the
foreseeable future. We believe Nabors and Patterson-UTI's
technologically-advanced units will continue to benefit from an
upswing in U.S. land drilling activity and the shift to complex
onshore plays that require highly intensive solutions.
China's CNOOC Ltd. (
) 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 infrastructure. The acquisition of
Canadian energy producer Nexen Inc. has further improved CNOOC's
growth profile by augmenting proven reserves by 30%, while helping
it to vastly expand its holdings in Canada.
Weak propane prices have prompted us to be bearish on independent
refiner and midstream services provider Phillips 66 (
). We are also concerned by the company's aggressive growth plans
that require high level of capital spending, which may eventually
result in reduced returns going forward.
We are also skeptical on Italian energy company Eni SpA (
). 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 engineering and
construction firm McDermott International Inc. (
). The company's steep operating costs, an erratic earnings trend
over the last few quarters and lack of clarity about some of the
big projects have made us bearish about the firm's near-term
Contract drilling services provider Noble Corp. (
) is another company we would like to avoid for the time being.
Apart from volatility in the macro backdrop, a sequential decline
in the company's fleet utilization and a drop in backlog continue
to concern us. Moreover just 74% and 50% of available rig operating
days for the remainder of 2014 and 2015 have been committed.
Lastly, we recommend against buying legacy offshore drillers like
Transocean Ltd. (
). The most pressing concern for the group, at least in the
short-term, will be oversupply in the rig market. With
multinational energy biggies looking to reign in their skyrocketing
capital expenses, the offshore drilling space is likely to see
intense competition, as multiple firms run after a single contract.
This excess capacity, in turn, could lead to lower utilization or
dayrates. As the sector looks set to enter a cyclical downturn and
struggle with idled rigs, we do not see an immediate rebound in the
sentiment and expect more punishing times ahead for the likes of
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