- Oil markets have rallied in recent weeks, following a historic price collapse that sent US crude into negative double-digits.
- Some companies will face headwinds in the years to come as they try to recover lost production, according to a Morgan Stanley note published Tuesday.
- But a handful of others are highly resilient at low prices and positioned to “thrive” in the recovery, the bank said. Here are its top 5 picks.
- Visit Markets Insider to view the latest on oil prices.
As lockdowns ease, demand for gasoline and other oil-based fuels is starting to return, helping oil markets recover from steep losses suffered in April.
On Tuesday, the US crude oil benchmark, West Texas intermediate (WTI), hovered around $32 a barrel — up more than 50% since the start of the month.
“Crude oil demand has recovered faster than market expectations,” analysts at Morgan Stanley led by Devin McDermott said in a note Tuesday.
Although oil markets are recovering, his team said it favors stocks that are “resilient” at low prices and positioned to generate cash as they continue to rise.
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Rebounding fuel demand is just one force behind the recent rise in oil prices, the analysts said.
Months of cheap oil forced North American producers to cut production by about 1.5 million barrels per day and slash their budgets, which the analysts said has helped moderate supply.
Coupled with record cuts from OPEC and its allies, these curtailments have helped buoy energy stocks.
Since April 1, the Dow Jones US Oil and Gas Total Return Index — which tracks companies in the industry — is up about 34%, while the Dow Jones Industrial Average is up just 12%.
“The worst has likely passed and the sector is unlikely to re-test the March lows,” McDermott’s team said.
But cuts to capital expenditure, and resulting production declines, could hamper some exploration and production (E&P) firms in the long term, the analysts said.
“While capex reductions are necessary to manage through the current commodity price uncertainty, many E&Ps will face headwinds from production declines, higher cost structures, and rising leverage levels,” they said.
Some companies, for example, might have to spend more in the future to offset the production cuts they’re making today, which could limit cash flow.
Plus, there’s still a lot of uncertainty in the industry at large.
“OPEC compliance has shown cracks,” the analysts wrote, adding that they “continue to see risk the cartel will defend market share over time.”
The upcoming presidential election could also disadvantage certain oil and gas giants, his team said.
If Democratic nominee and former vice president Joe Biden wins the election, he may ban drilling in federal lands and waters.
That puts companies with high exposure to federal lands — such as Devon Energy and EOG Resources — in a more challenging position, they said.
With this in mind, Morgan Stanley says it favors oil and gas companies that are “resilient” at low oil prices and that will generate a lot of cash as oil prices rise.
These companies will be “positioned to survive the downturn and thrive during the recovery,” the analysts wrote.
Here are the bank’s top five picks.
- Chevron. The California-based firm “offers resilience to lower oil prices along with attractive leverage to any potential recovery,” the analysts said. Even with the international oil benchmark, Brent, at $30 a barrel for two years — a little below what it is today — the company can “invest in the business, sustain its dividend, and still exit 2021 with a net debt ratio of less than 25%.”
- Hess Corp. Hess is another example of a resilient company, Morgan Stanley said. The company has “highly economic, long-cycle growth in Guyana,” coupled with short-cycle projects in the Bakken oil field of North Dakota and Montana. Hess has also hedged about 80% of its oil production this year, the analysts said, “limiting exposure to weak prices” in the near-term.
- Noble Energy. “The company is uniquely insulated from depressed oil prices through contracted gas sale agreements in offshore Israel,” they wrote, where gas prices have remained more stable. The company has one of the lowest prices for breakeven cash flow among the bank’s coverage, McDermott’s team said.
- Parsley Energy. The Texas-based company is trading at a “significant discount to peers,” they said, mentioning that it has “peer-leading metrics” including a breakeven price of oil of just $7 per barrel after dividends.
- Cimarex Energy. Low natural gas prices in the Permian basin were initially a “headwind” for Denver-based Cimarex, the analysts said, but “now likely declines in Permian oil production should help alleviate gas constraints in the basin.” The company can also fund maintenance expenses and its dividend at just $30 a barrel — below today’s price of US crude.