How Lower Oil Prices Are Affecting Oil And Gas Companies

Following yesterday’s discussion about the coal industry, where stock pullbacks seemed more or less undeserved, today we look at the oil and gas sector with Zacks senior analyst Sheraz Mian. With the price of a barrel of oil pulling back drastically, does this warrant the significantly lower oil prices?

With oil prices headed to roughly half what they were just a few months ago, how has this affected oil companies under your coverage?

The current market turmoil has been particularly brutal in the oil space, with all sub-sectors getting down to levels not seen in years. While expectations of softening oil demand over the coming quarters and broad credit-market concerns have been the primary reasons for the sector’s woes, the sell off has by all measures been over-done.

This indiscriminate sell-off has made the risk-reward trade off of a number of sub sectors very compelling, in our view. Our best ideas are in the integrated, oilfield service, and offshore drilling sub-sectors.

Where do you see oil prices heading in the near term?

While downside risks still remain, particularly if the global economic weakness turns out to be more protracted than currently anticipated, oil prices are expected to consolidate around current levels. We expect crude oil prices to bottom around $70 a barrel.

We are strong believers in the secular underpinnings of the oil cycle; the current downturn is just a pause in a long secular cycle that still has plenty of room to go.

In which areas would you advise investors to look for oil stocks?

The large-cap integrateds Exxon (XOM), Chevron (CVX) — remain the best positioned given their energy conglomerate business structures, stellar balance sheets, substantial free cash flows, and growing dividends.

The underlying business fundamentals of integrated oilfield service companies such as Halliburton (HAL) and Baker Hughes (BHI), as well as deepwater-capable drilling contractors like Transocean (RIG) and Diamond Offshore (DO) still remain robust. Oil prices will need to drop even further and then stay there to materially impact their operating outlook.

Are there any caveats we should be aware of?

Growing domestic production and moderating demand, particularly from industrial consumers, is expected to weigh on natural gas prices for the remainder of this year and next.

The tentative natural gas price outlook, which preceded the credit-market related turmoil of the past month, is expected to cap the upside in the exploration and production (E&P) space. This group also has credit market exposure.

This outlook reflects credit markets getting back to normal over the coming days, a three/four quarter period of negative economic growth in the OECD markets, and decelerated growth in the emerging world. An outcome worse than this outlook represents a clear downside risk.

Sheraz Mian is a senior analyst covering the oil & gas industry for Zacks Equity Research.

Subscribe by RSS Subscribe by Email