Sector Rotation

[dan_s]

If this is a repeat of 2010 (the last stage of the last oil price cycle), we should see many fund managers "rotate" into high quality upstream names. This happens on the theory that last year's beaten down sector will rebound in 2016. Upstream and midstream energy companies are vital to maintenance of our standard of living. Some companies won't make it and we will see others swallowed up in takeovers, but the industry will survive.
In 2010, the Sweet 16 made a nice move in the first quarter, stabilized in Q2 and then took off in the back half of the year when the market gained confidence that oil supply / demand were back in balance. I do not think oil prices will return to the $100's unless the U.S. dollar pulls back. However, with lower drilling & completion costs and improved well results, $60/bbl will "feel like" $100. I do see the potential for a global oil shortage as early as 2017. - Dan

Barron's December 22, 2015, 1:10 P.M. ET
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12 Oil Stocks for a Second-Half Energy Rebound

By Ben Levisohn

RBC’s Scott Hanold and team believe so-called quality oil stocks will perform well during the first half of 2016, but that it will be time to buy “beta” in the form of companies like Devon Energy (DVN), ConocoPhillips (COP), Rice Energy (RICE), Continental Resources (CLR), and Whiting Petroleum (WLL) during the second half of the year. They explain:

The bifurcation of US E&P stocks is more prevalent now than in recent history. Investors have moved to “safety” and “quality” given the backdrop of both lower oil and natural gas prices. There is a high correlation with lower leverage and stock price performance over the past year. Ownership in the E&P space has become more consolidated with most long only and hedge fund investors focusing on a few names (long side), including Callon Petroleum (CPE), Concho Resources (CXO), EOG Resources (EOG), EQT (EQT), Matador Resources (MTDR), PDC Energy (PDCE), Pioneer Natural Resources (PXD), RSP Permian (RSPP), Parsley Energy (PE), Occidental Petroleum (OXY), Newfield Exploration (NFX).

Our strategy for 2016 is to stay with “quality” in 1H16 but start to look at beta around mid-year as the commodity markets improve. We are expecting oil prices to stay low in 1H16, but recover in 4Q16 to $60/bbl. We expect global oil market conditions to fundamentally improve over the course of 2016 amid respectable demand growth but with WTI upside to $60/bbl or less. Oil prices are likely to trade in an extremely wide band of $45–60/bbl. A sustainable oil price recovery appears more on the cards in 2017—as longer cycle-time projects begin to lose their steam. We think stocks with lower leverage, good asset quality, and “cheap” valuation are likely to perform the best and earlier: Devon Energy, Apache (APA), Continental Resources, ConocoPhillips, Carrizo Oil & Gas (CRZO), EP Energy (EPE), Gulfport Energy (GPOR), Newfield Exploration (NFX), Oasis Petroleum (OAS), Rice Energy, SM Energy (SM), Whiting Petroleum.

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PS: It is the high quality small-caps that generate the big gains. - Dan