Being raised in South Texas, I am very familiar with the Oil Industry. I live in San Antonio which has become the de facto headquarters for many energy companies prospecting for profits in the Eagleford Shale unconventional play. I was involved in the industry as a registered representative for a securities broker offering shares to accredited investors in oil & gas exploration joint ventures with major oil & gas companies. This was a way for accredited investors to participate directly in the black gold rush. Most people don't qualify for these types of investments so I decided to write an article detailing my bull case for the Oil & Gas market and some of my top picks in the industry.
I believe we are at an inflection point regarding the global energy market. I see oil supplies dwindling while demand has nowhere to go but up once the economies of the world get back on track. Allocating a portion of your portfolio to the growing U.S. energy sector seems only prudent as a hedge against rising energy prices. The following is my bull case for the Oil & Gas sector and five potential buying opportunities.
Major Macro Catalysts for U.S. Oil and Gas Companies
Chinese and Emerging Market Demand is Rising
Chinese and emerging market demand growth is rising. Foreign energy companies are chomping at the bit to get in on America's black gold rush. Total (TOT) and China's Sinopec (SHI) are recent entrants. Total recently closed a $2.32 billion deal on a 25% stake in an Ohio shale deposit operated by Chesapeake (CHK). Sinopec recently paid $900 million and pledged to cover up to $1.6 billion in drilling costs for a 33% stake in Devon's (DVN) portfolio of properties. Additionally, emerging market countries (China and India) are increasing their strategic reserve stockpiles by up to threefold. This will continue to drain supply from the market causing prices to escalate.
Middle Eastern Instability Is Here To Stay
At least a 10% Middle Eastern instability premium is priced into Oil & Gas due to Iranian and Syrian tumult. The European Union reached a preliminary agreement to ban imports of Iranian crude, intensifying strains in the West's impasse with Tehran. Tensions have been amplified with recent threats to peace being ratcheted up due to Iran's quest to acquire a nuclear weapon. Syria is allegedly killing unarmed protestors inside the country currently. Unfortunately, I don't see this premium ever dissipating. As soon as these issues are resolved, new ones will move to the forefront to take their place. The Middle East will be a tinder box for the foreseeable future in my mind.
U.S. Economy Improving as European Sovereign Debt Fears Subside
The Federal Reserve slightly upgraded its economic outlook on Tuesday, stating it expected "moderate" growth over coming quarters and a gradual decline in the unemployment rate with the caveat that the jobless rate will remain elevated. Better than expected U.S. consumer confidence, housing sector and manufacturing statistics have been positive. At the same time, the nightmare scenario for Europe seems to have been avoided. These developments should lead to a pickup in economic activity. This will inevitably lead to increased demand for energy.
U.S. Federal Reserve and Global Central Bank Monetary Policies
U.S. Fed and ECB printing presses are working overtime to paper their way out of massive debts. I posit at some point inflation will come in to play and underpin the price of Oil & Gas. The central banks have created a virtual win-win scenario for oil & gas companies. Either the economy gets better and demand rises or the economy gets worse and the central banks crank up the printing presses increasing inflation risk.
Who Is Profiting In The U.S. Oil Patch?
I have chosen to highlight the top five most profitable large cap U.S. Energy industry stocks in the S&P 500. A company's profitability is conceivably the most important statistic to understand before investing in a stock. Each time you consider starting a position in a stock, you should prudently scrutinize its earnings information. Apache Corporation (APA) with a net profit margin of 27.14% leads the way. Occidental Petroleum Corporation (OXY), Devon and Pioneer Natural Resources (PXD) follow with net profit margins of 25.95%, 18.63% and 16.46% respectively. Chesapeake Energy brings up the rear with a 15.10% net profit margin. Apache has the best P/E ratio at 7.81 closing followed by Chesapeake at 8.37. They all are below industry average with the highest belonging to Pioneer with a P/E ratio of 13.98. Use this as a starting point for your own due diligence on these companies.
Current Buy on Weakness Opportunity
All these stocks are trading down one to two percent currently based on recent developments. Crude oil futures dove Wednesday as U.S. crude stockpiles rose last week the fourth consecutive time. What's more, the dollar is up in softening investors' enthusiasm for riskier assets such as oil. Nevertheless, I see this as a temporary circumstance and consider it a short term buy on weakness opportunity for these stocks. You have to buy low to sell high.
With the current tumultuous events in the Middle East bringing attention to the mounting energy requirements of the emerging economies, in addition to the burgeoning necessities of the recovering developed economies, the fact that demand will eventually outstrip supply appears obvious. All the easy oil and gas has been discovered, recovered, depleted and expended. We are now left with on shore 'fracking' and deep sea drilling which are much more expensive endeavors, ultimately driving the price of a barrel of oil sky-high sooner rather than later. The five most profitable companies listed in this article are well positioned to take advantage.
Use this information as a starting point for your own due diligence and research methods before determining whether or not to buy or sell a security. If you choose to start a position in any stock, I suggest layering in a quarter at a time on a weekly basis to reduce risk and setting a 5% trailing stop loss order to minimize losses.