Fall themes for investing in oil and gas emerged in analysts’ reports in September. Morgan Stanley focused on energy stocks that presented ways to play what it termed the “Permian pause,” while Bernstein Research analysts added general strategies to its discussion of the prolific basin’s current slump driven by takeaway constraints.
The Morgan Stanley North American team expected continued pressure on Midland oil prices for Permian players to the end of the year and, possibly, beyond. “We expect Midland prices to fall to $35 to $45 per barrel (bbl) by fourth-quarter 2018, which equates to a differential of $27 to $33/bbl to West Texas Intermediate (WTI) on strip prices.”
That would be a significant rise from the Permian differentials averaging $15/bbl at the time of the report. The analysts say that it will take Permian prices of $40/bbl WTI to slow activity in the basin and moderate the constraints until pipeline capacity catches up, which is not expected until late 2019 to early 2020. To the extent that some Permian-focused equities have not suffered as much as they might have from this price shortfall, the Morgan Stanley analysts expect that underperformance is probable.
“Across our energy coverage, overweight rated Occidental Petroleum Corp. (NYSE: OXY) and Delek US Holdings Inc. (NYSE: DK) are our top picks to play widening differentials, since both are direct beneficiaries,” they said.
Those equities that they see as having significant exposure to differentials and a resulting slowdown in activity in the basin are Cimarex Energy Co. (NYSE: XEC), Concho Resources Inc. (NYSE: CXO) and Parsley Energy Inc. (NYSE: PE).
The analysts’ most preferred names in the Permian are Occidental, because of its ability to benefit from differentials; Pioneer Natural Resources Co. (NYSE: PXD), which has export capacity to help protect it; Diamondback Energy Inc. (NASDAQ: FANG), which is still “cheap”; and Encana Corp. (NYSE: ECA), which has “200% and 93% of its 2018 and 2019 Permian oil production protected with firm takeaway and hedges, respectively…”
Bernstein Research analysts look for industry themes to include companies sticking with what has worked for them in the past. EOG Resources Inc. (NYSE: EOG) and ConocoPhillips Co. (NYSE: COP) fit this bill among the E&Ps Bernstein covers.
As for the Permian problem, the analysts forecast that consolation will be the end-game for the crowded basin. Secondly, like Morgan Stanley, they think the bottom of Midland pricing has not yet been reached but added that “clearly when it happens, Concho in our coverage is the natural way to play it [as well as Pioneer].”
The Bernstein team sees a Scoop/Stack theme in the months ahead. “We’d argue that from a below-ground perspective, we may have seen the worst of the Scoop/Stack woes,” they said. But there’s a caveat above-ground: they note that because of these players’ strong dependence on NGL for workable economics, pipeline shortages could also be problematic in Oklahoma.
Investors might keep an eye on the Powder River Basin, they said, given that companies devoted a lot of discussion to it in the recent earnings season. In that arena, they note. Chesapeake Energy Corp. (NYSE: CHK) is the “greatest potential game-changer.”
Overall, the report looks for upside to top pick Pioneer of 44%; Anadarko Petroleum Corp. (NYSE: APC), 32%; EOG, 30%; Encana, 19%; and ConocoPhillips, 11%.
And finally, the Bernstein report referenced the oil macro theme. “In general, we’d argue for a positive bias to commodity prices,” they said.
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