With oil prices having more than doubled from their early 2016 low, to over $65 per barrel, traders are waking up this morning to the possibility that the long-dormant oil sector may be coming back with a vengeance.
Today’s prices allow drillers to hedge for $60 per barrel oil for over one year, meaning they now have a platform for new investment. Production recently passed its 2014 peak of 9.6 million barrels per day and is showing no signs of slowing down.
As a result, analysts are starting to pound the table for oil stocks again, especially those with relatively low debt loads. The new names are players like Jagged Peak Energy Inc. (NYSE:JAG), Diamondback Energy Inc. (NYSE:FANG) and RSP Permian Inc. (NYSE:RSPP), frackers with “interesting” acreage in the Permian Basin that have grown their operations since the bust.
Low Debt, Low Risk
Traders don’t yet trust the rise in prices, largely thanks to the accompanying rise of production. This is why integrated oil companies like Exxon Mobil Corp. (NYSE:XOM) and Chevron Corp. (NYSE:CVX) remain relatively cheap, with Exxon selling for less than twice its annual revenue, despite having less than 10% of its assets under debt.
Diamondback is typical of the names getting the most play right now. It has just $1.256 billion in debt on $7.287 billion in assets, and it has been showing profit margins of nearly 50% for almost a year now.
Diamondback has spent the oil bust raising cash and buying acreage in the Permian Basin, and now all its production is profitable. This means the company is ready to leverage high prices onto the bottom line, even after losing $550 million, on revenue of $495 million, as recently as 2015. The company is next due to report earnings Feb. 13 and analysts are expecting $1.49 per share of earnings and $338 million of revenue. That would give it over $5 per share of earnings for the year, on a stock price of $130.
Jagged Peak has a slightly higher risk profile, as it is drilling on land that other companies have questions about. But it has just $35 million in debt on $935 million in assets and analysts are expecting 10 cents per share of earnings and $105.2 million in revenue when it reports Feb. 7.
Eagle Ford Next?
The Eagle Ford play, which winds from the Mexico border around south Texas and up toward Dallas, should also start to see new interest if prices remain where they are.
Production there is starting to rise again, thanks to new rigs producing at a high rate. Drilling is rising in the center of the play, in Karnes County southeast of San Antonio, with EOG Resources Inc. (NYSE:EOG) being among the most active, having gotten its debt down to less than 25% of assets in recent quarters.
These are not yet the go-go days of early this decade, when the skies were filled with lights and flares from wells along I-37 between Corpus Christi and San Antonio. This is a slower, more methodical climb by larger players with plenty of capital.
The Bottom Line on Oil
There is still plenty of time for smaller investors to get into the new play, because there is still widespread belief that it’s all just a mirage.
I’m conservative when it comes to oil stocks, and like Exxon Mobil here. It’s paying a dividend that now yields 3.46%; it has covered that dividend with earnings for three quarters running; and its operating cash flow has been rising steadily.
Oil is one of the few areas of this market where you don’t have to reach for value right now. You can go for yield, you don’t have to grab debt, and the crowd has yet to rush in.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story.