Oil Will Turn Soon, But Not All Oil Companies Will Follow

 | Aug 14, 2017 | 2:00 PM EDT
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We're finally approaching a time when oil stocks are going to be investable again. We've endured a long winter, where bad business practices have been represented with equally bad share prices. But finally, many of the weakest oil companies are out of money and are being forced to cut costs and production targets.

This is what we've been waiting for. We've been waiting for the time when the oil company "wheat" will separate itself from the "chaff." That time is now.

I believe oil prices will get constructive soon, overcoming their year-long range between $43 and $54 dollars a barrel. We can see three factors that are going to push oil out of this range to the upside. First, we see oil stockpiles falling under the 5-year average, signifying the rebalancing is coming. Second, we see rig counts beginning to roll over, making the projections for increased production in 2018 far too optimistic. And third, major rollbacks of capex from oil producers, announced in their second-quarter reports, are going to accelerate both of these trends.

But don't get too excited -- there is a big, big problem with just buying any oil stock. We've seen, over and over again, that higher oil prices do not translate into higher stock prices equally -- we have to be very, very selective in which stocks to buy in order to take advantage of the higher oil prices to come. Many of the most leveraged names in shale have continued to sink lower, despite oil prices that have stabilized near to $50.

We're looking for a few good names.

Those names will come from companies that have exhibited discipline -- and haven't pursued higher production at all costs. We want companies that haven't turned the spigot up to full blast in an oil environment that promised only 10 dollars of profit per barrel -- if that much -- instead of the 30 or 40 dollars of profit that oil prices prior to 2014 would have brought. We want companies that have drilled core acreage at a steady but slow pace, and have years of core acreage yet to develop, instead of those that have perhaps another year or two of quality spots to drill, before being forced to move to the 'B-team' or even the 'C-team' of acreage sites.

I give you three ideas to look at.

EOG Resources (EOG) has diligently continued to pursue their 'premium drilling' plans, only considering acreage with a proven profitability for development. They've continued to be a lone leader in free cash flow for fracking operations, a difficult benchmark in a high capex business like shale. Even though their stock is hardly at a discount, they still represent a 'best in breed' opportunity that will respond to higher oil prices.

Cimarex (XEC) has been a core holding of mine and has remained a disciplined player in the Permian, even though their West Texas acreage consistently yields a higher average of natural gas than most. But disciplined operations have yielded a quarter that far surpassed everyone else in the field, proving that they are nearly alone in raising production when many others will be out of money and cannot.

Apache (APA) is more speculative, driven mostly by the unsure opportunity given by their Alpine High acreage, where development costs are a fraction of others in the Permian. While so far results have been less than stellar and Apache remains a cash flow negative operation, their recent consolidation and concentration on prime assets should turn that around in the higher oil price environment I envision in the second half of 2017. At 52-week lows, shares remain an interesting turn-around play for higher oil prices.

While oil is about to break out of it's range, the same is not true for all the oil companies. Those that have been disciplined through the very long downturn in oil prices will be the ones that will reward investors the most as oil prices start to move higher.

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