- After a historic oil price rout, energy markets appear poised for a slow yet enduring recovery, according to Wall Street analysts.
- US producers have announced production cuts amounting to more than 1 million barrels of oil per day. Meanwhile, global demand for fuel is starting to return.
- “But not all companies that survive this downturn will be in a position to thrive when oil prices recover,” Morgan Stanley analysts said in a note Monday.
- The bank shared 12 oil and gas companies that are well-positioned to ride the recovery and 10 that could be weighed down by an “unsustainable strategy.”
- Visit Markets Insider to view the latest on oil prices.
The impact of cheap oil has been swift and painful.
Dozens of companies across the US shale patch have slashed their capital budgets, laid off workers, and announced steep production cuts — amounting to more than 1 million barrels of oil per day.
But while painful, those cuts are helping to stabilize a market reeling from an epic oil surplus, according to analysts at Morgan Stanley, led by Devin McDermott.
“The industry is responding as it should,” they wrote in a note Monday.
At about $24 a barrel, the price of the US benchmark, West Texas intermediate (WTI), is up about 25% since the start of the month — and double what it was just two weeks ago.
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Coupled with signs that demand for fuel is starting to return, analysts are now cautiously optimistic that oil markets may be on a path to recovery.
Yet it’s clear that not all companies will make it out alive. And those that do won’t see equal gains from a recovery, McDermott’s team said.
“Not all companies that survive this downturn will be in a position to thrive when oil prices recover,” he wrote.
A recovery draws near
In the past month, energy firms focused on exploration and production, known as E&Ps, have outperformed the overall market by 15%, McDermott’s team said — “reflecting signs of improving oil demand.”
What’s more, several companies now have the ability to sustain oil production if the price of US crude is at $35 to $40 per barrel, thanks to improvements in the firms’ capital efficiency, they said.
“In fact, several producers said they could quickly reverse shut-ins and increase activity should prices return to $25-35,” the analysts wrote, including Parsley Energy, Diamondback Energy, and Cimarex Energy.
Producers will continue to face ‘headwinds’
Still, the bank cautioned, most producers need prices in the range of $40 to $50 a barrel “to begin resuming growth.”
Even in a market recovery, several companies will continue to face higher costs, rising debt, and lower oil production — “headwinds that will limit fundamental upside in a recovery,” the bank said.
Plus, the price of oil isn’t expected to reach its pre-pandemic levels for months if not years.
The analysts don’t expect “oil prices to rally strongly in the near-term” — in part, because they expect the cartel of oil-producing nations known as OPEC to continue trying to gain market share.
That will result in “a structural headwind for oil prices and E&P equities relative to current valuations,” they wrote.
Where Morgan Stanley is placing its bets
For the last several weeks, Morgan Stanley has reiterated its preference for oil and gas companies with “resilient” outlooks and “strong balance sheets, hedges, and low breakevens.”
“We continue to favor companies that offer attractive [free-cash-flow] leverage to the upside when we ultimately exit this downturn,” McDermott’s team wrote.
The bank has an over-weight rating on integrated oil giant Chevron (CVX) and E&Ps ConocoPhillips (COP), Noble Energy (NBL), and Hess (HES), in addition to the Permian Basin producers Pioneer Natural Resources (PXD) and Cimarex Energy (XEC).
An over-weight rating indicates a stock that the analysts favor, while an under-weight rating is one they suggest investors avoid. Equal weight indicates the analysts have a neutral outlook on the stock.
Though rated equal weight, Concho Resources (CXO), EOG Resources (EOG), Devon Energy (DVN), and Parsley Energy (PE) are also strong picks, Morgan Stanley said.
As far as natural gas goes, the analysts write that they “favor dry gas producers with relatively less leverage and stronger free cash flow profiles.” Those producers include equal-weight stocks Cabot Oil & Gas (COG) and EQT Corporation (EQT).
Companies with an ‘unsustainable strategy’
On the flip side, actions to preserve cash in the near-term could leave a handful of other exploration and production companies “with meaningful production declines, a higher cost structure, and rising leverage over time,” the analysts wrote.
Altogether, that’s “an unsustainable strategy that effectively impairs the business,” they said.
Firms that fall within that diagnosis include under-weight Occidental Petroleum (OXY) and Continental Resources (CLR), in addition to equal-weight Marathon Oil (MRO).
Most smaller, high-yield E&Ps — including Callon Petroleum Company (CPE), Chesapeake Energy Corporation (CHK), Oasis Petroleum (OAS), and Murphy Oil Corporation (MUR) — also fall into that unsustainable category, the bank said.
Finally, Morgan Stanley writes that the debt outlook “remains challenged” for most of its small- and mid-cap high-yield coverage. The bank rates Antero Resources (AR), Range Resources (RRC), and Southwestern Energy Company (SWN) all under-weight.