4 Underrated Profit Plays For Higher Oil Prices
You don’t only have to invest in the big oil companies to earn profits from an increase in the price of the black gold. These four picks should do well even with just a modest increase, and it looks like 2017 is the year that could happen.
The trading week has begun with a nice rise in crude prices as oil looks like it is finally breaking out of the $40 to $50 a barrel range it has been stuck between for a couple of quarters. On Monday, OPEC was joined by non-OPEC nations, primarily Russia, in an agreement to cut oil production.
Recently OPEC had agreed to cut production by some 1.2 million barrels a day with Saudi Arabia ponying up over 450,000 barrels a day of that agreed to cut.
They were joined this week by 11 non-OPEC nations that agreed to cut another 558,000 barrels a day from their production. This was the first time non-OPEC nations had joined their OPEC brethren in such a cut since 2001, so it was treated by the market as a significant event. Oil touched $54 a barrel on Monday after catching word of this news.
This supports one of three themes that I recently articulated for 2017 in that oil should move up to a higher trading range of ~$55 to $70 a barrel in the first half of the year. I don’t think these cuts are going to take us back to the days of $100 a barrel oil.
To begin with, global growth is still anemic. More importantly, thanks to their massive increases in production over the past decade, shale producers have become one of the most important swing producers in the market. A move up to $55 to $60 a barrel could easily make another 800,000 to 1,000,000 barrels a day profitable to bring online with minimal investment from existing drilling infrastructure.
The production increases in the United States are here to stay for a long time. We have just started exploring the Wolfcamp basin, which contains at least 20 billion barrels of recoverable oil and is one of the biggest finds in recent decades. This new administration will also have a much more pro-energy stance than the outgoing administration. Both natural gas and oil production on Federal lands have actually fallen over the past eight years, even as they have boomed on private acreage.
Therefore, I am not making major changes in my portfolio allocation on the prospect of slightly higher oil prices in 2017. I did take profits in Delta Airlines (NYSE: DAL) on Monday after an approximate 35% surge since August, including dividends.
This cyclical nature of airlines usually makes them more trades than long-term investments. Delta looks close to fully valued here and is bumping up against the median analyst price target on the stock as well. Jet fuel is a major component of operational costs, and although forward needs are largely hedged; a higher oil price will dampen investor enthusiasm for this sector of the market.
However, I am sticking with Ford (NYSE: F) and General Motors (NYSE: GM).
If oil stays below $70 a barrel, gasoline prices should not go up enough to see demand dampen for these automakers’ trucks and SUVs. This is a key given that these vehicles carry much higher margins than mid-size and small cars, currently making up over 50% of overall sales. This has happened over the past year for the first time since 2005 as the collapse in oil prices and lowering of gasoline costs affected consumer behavior in vehicle purchasing decisions.
Both companies are also growing market share in China through joint ventures. They are seeing solid domestic sales as well. Both manufacturers could benefit from the incoming administration, which should address unrealistic future fuel standards. This administration could very well reverse many electric car incentives and tax credits, as well as some other onerous regulations. Finally, both stocks are cheap at under seven times earnings with solid dividend yields.
I am also sticking with a small energy producer called Synergy Resources (NASDAQ: SYRG), even though it has moved up some 50% since I profiled it on these pages in November. If oil does move up into the mid-range of my projected $55 to $70 a barrel, more upside should be ahead of this small E&P play.
I also recently picked up a new stake in the giant refiner, Valero (NYSE: VLO). A widening crack spread would be good for its prospects. In addition, I think some of the rigid ethanol mandates for many refiners will be lessened under this incoming administration, judging from its recent nomination to head the EPA.
Valero has long opposed the Renewable Fuel Standard, which is the U.S. law that forces refiners to use increased amounts of ethanol and biodiesel. It might have some luck in pushing back on this program in coming years. Barclays recently added the largest North American refinery play to its “top picks” for 2017 list. After being down slightly this year, profits should jump in 2017 while the stock also pays a 3.5% dividend yield. Valero is a free cash flow machine and has a pristine balance sheet.
Even as we look forward to 2017 I’m looking at a stock right now that could give us a nice end of year pop then set up for big gains early in the new year. It has a key catalyst date of February 28, 2017. This event is expected to propel the stock by as much as 66% in short order, perhaps even more. In my new briefing I detail how this may be the best investment you make in 2016 and how you can expect windfall profits in 2017.
Positions: Long F, GM, SYRG & VLO
Category: Commodity Stocks, Crude Oil
