Drilling rigs and derricks at a Devon Energy site in Oklahoma City. Devon is among Siebert Williams Shank’s top oil picks.
Zeytun Images/Dreamstime.com
There has been a growing consensus on Wall Street that oil prices will stay high, and that energy stocks can continue their upward swing.
That confidence was reaffirmed on Thursday as oil prices spiked on expectations that OPEC will continue with accommodative policies. But not everyone is convinced.Gabriele Sorbara, an analyst at Siebert Williams Shank, wrote on Thursday before the OPEC meeting that oil prices were likely to come down — and put a lid on some of the recent moves by stocks in the industry
A “normalized” price environment, he says, would take West Texas intermediate oil back down to $55 a barrel. He sees gas prices rising to $2.75 for a thousand cubic feet (or $2.85 per million British thermal units, the measure used in futures markets.)
On Thursday, West Texas crude futures were up 2.1%, to $62.54 a barrel, and natural gas was down 1.9%, to $2.76 per million BTUs.
Oil is rallying because OPEC and its allies may add production back to the market more slowly than investors had anticipated — raising the possibility that demand outpaces supply more significantly in the months ahead.
“At the end of the day, the market yesterday signaled it was looking for 1.5 million barrels per day additional supply in April, and OPEC tested the reaction to less, which led to oil trading upward,” said Chris Midgley, global head of analytics at S&P Global Platts. “Anything less than 1.5 million barrels per day will bring into question whether OPEC has left it too late to add oil onto the market before the summer demand surge.”
Sorbara agrees that OPEC can help keep oil prices high if it extends supply cuts, but he thinks that oil prices won’t be able to rise in the future without more evidence of a resurgence in demand.
The analyst thinks investors can still make money in oil and gas stocks, but they have to be choosy. Oil and gas names face regulatory risk from Biden administration moves that could affect access to pipelines and drilling on federal lands. And the cost of oil services may rise along with the commodity, eating into margins, Sorbara warns.
He suggests investors focus on higher-quality names.
“It is prudent to position more defensively to quality, which has underperformed over the past few months and presents relative value,” he wrote. His top picks are Devon Energy (ticker: DVN), PDC Energy (PDCE), Cimarex Energy (XEC), and Diamondback Energy (FANG). Devon and Diamondback, he says, “stand out as beat‐and‐raise stories for 2021.”
Marathon Oil (MRO), however, was downgraded to Hold from Buy on valuation following that stock’s recent outperformance.
Devon is trading at a lower valuation than peers, and Somara thinks that the company can navigate new federal rules that could limit drilling on federal lands, because it has stockpiled four years worth of permits. His price target is $29. Devon was up 2.3% on Thursday to $23.21.
Diamondback also looks cheap to Sorbara because its guidance for 2021 looks conservative, and the stock could rise if it beats expectations. His price target is $89. The stock was up 9.8% on Thursday, to $81.74.
Sorbara, notes however, that the rally may continue even if the economics don’t justify it: “A weakening dollar, inflation risks and money flows (including continued rotation into small-caps and value stocks) could all add fuel to the momentum and drive commodity prices and the sector higher regardless of fundamentals.”
Write to Avi Salzman at [email protected]
