Energy stocks are suddenly hot, a strange phenomenon for a sector whose prospects on paper couldn’t possibly look worse. But Wall Street now has warmed to the stocks and analysts are getting more bullish.
Goldman Sachs analysts, for instance, have issued reports in recent days recommending investors buy a range of energy stocks, from refiner Valero (VLO) and producer ConocoPhillips (COP) to riskier names including Canadian company Cenovus Energy (CVE).
Oil stocks have struggled for years to attract investor interest, to little avail. Last year, energy stocks ended the year making up less than 5% of the S&P 500, the lowest level in decades. The same pattern had been developing this year, until Covid-19 struck. In March oil prices crashed, along with the stocks. In April, oil prices crashed again, but the stocks have been rising. In fact the SPDR S&P Oil & Gas Exploration & Production (XOP) is up 66% since the start of the month. Of course, it is still down 42% for the year, but there is clearly momentum.
Analysts are increasingly seeing value in the industry. Looking at near-term oil prices, there seems to be little reason for optimism. Even after an 8% jump on Thursday, West Texas Intermediate crude futures were trading at $18.84 a barrel, a price that will drive most producers in the U.S. out of business if it holds for more than a year. But investors expect prices to rise to more than $30 a year from now, and higher from there.
Goldman Sachs analyst Bryan Singer projects that Brent crude could trade at $60 in the second half of 2021. (Brent crude was up 11% to $25.27 on Thursday.) He favors two producers he considers “quality on sale”— EOG (EOG) and Pioneer Natural Resources (PXD). He also likes oil-services company Baker Hughes (BKR).
Singer argues that oil stocks are in good shape now because the industry has finally set itself up for better performance. The announcement from OPEC+ that it will cut production by 9.7 million barrels, and expectations for large closings of wells in North America should result in a large decline in production. As supply drops, that should allow shale production to eventually rebound, instead of muddling along at low levels for years. Larger-scale oil projects have also been put on hold, meaning that supply growth now looks more muted. “Assuming normalization in demand, this has the potential to sustain higher prices by accommodating greater OPEC/shale growth,” Singer wrote.
In a separate Goldman report, analyst Neil Mehta wrote that investors can profit by taking a “barbell approach” to investing in the industry. That would entail buying both low-beta and high-beta names (with beta referring to risk or volatility in each name). That way they can benefit from well-capitalized companies able to withstand difficult conditions, while also taking on some more risk (and more potential upside) by buying stocks that will move dramatically on oil-price changes.
Mehta’s low-beta picks include Chevron (CVX) and refiner Phillips 66 (PSX)—companies with strong balance sheets that can draw more generalist investors. Others with relatively low beta include ConocoPhillips and Valero. His higher-beta names include refiner Marathon Petroleum (MPC) and Canadian integrated company Suncor (SU), names that Singer also likes. The highest-beta names Mehta favors are producers Kosmos Energy (KOS) and Par Pacific Holdings (PARR) and Canadian integrated company Cenovus Energy.
Write to Avi Salzman at firstname.lastname@example.org