3 Oil Stocks That Raise The Temperature… And One That Sizzles
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This article is excerpted from Tom Yeung’s Moonshot Investor newsletter. To make sure you don’t miss any of Tom’s potential 100x picks, subscribe to his mailing list here.
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Energy prices are rising
“Today, President Biden will sign an executive order prohibiting the importation of Russian petroleum, liquefied natural gas, and coal into the United States,” the White House announced this week.
The widely expected sanction caught traders off guard. Brent would rise to $140 a barrel before falling back to $110 in heavy trading. favorite meme Camber energy (NYSEAMERICAN:IEC) now has an implied volatility of 340; a $1 strike option for July will cost you 55 cents.
And much like my attempts at filling PB&J sandwiches, the love wasn’t evenly spread. American Energy Corporation of Houston (NYSEAMERICAN:HUSA) has increased by 570% over the past month, while BP (NYSE:BP) remains 26% below its 2020 level, due to its 19.75% stake in Russian oil company Rosneft. And pity traders who ended up on the wrong side of sanctioned bets.
Today we’re going to look at the fine line that separates the big winners from the losers. Hint: It has nothing to do with Russian drilling.
Source: Catalyst Laboratories / Shutterstock.com
The 3 oil actions that raise the temperature…
When I started my career as a commodity trader, my first lesson was:
Supply and demand economics is the gospel…at least for commodities like oil.
Countries with low production costs — like Saudi Arabia at $3 a barrel — don’t care if the price of “liquid gold” drops from $80 to $90. For them, it is often better to slow down production in order to raise prices even further. Meanwhile, regions with higher production costs (which generally have lower gross margins) will do the opposite. If my Canadian oil sands field is only profitable when prices are at or above $85 a barrel, you can be sure that even the accountants will help out on the rig if oil hits $200.
In other words, who wins and loses on rising oil has more to do with the choices they made years ago when deciding where to drill. A company’s proximity to Russian oil investments is secondary.
Biggest winner: Indonesia Energy Corp (INDO) +626%
The biggest winner of the saga was Indonesian Energy Company (NYSEAMERICAN:INDO), an oil producer with assets in Indonesia, unsurprisingly. Shares are up 626% in the past month.
INDO is a typical example of operating in a high cost region. Although Indonesia once produced nearly 2 million barrels of oil a day, the country’s output has fallen as its fields have aged. Today, companies like INDO often spend more on leases and operating expenses than they generate revenue.
Oil’s surge to $140 has given Indonesia’s aging fields a new (ahem) lease on life. Analysts now expect INDO (the company) to generate $18.6 million in revenue in 2022, a rate that will likely push gross profits up 7x to $10 million.
Enservco (ENSV) +596%
The second biggest winner was Enservco (NYSEAMERICAN:ENSV), a Colorado-based company that serves oil producers.
“President Joe Biden’s ban on Russian oil imports puts new pressure on U.S. drillers to help fill a supply gap,” Bloomberg energy correspondents Gerson Freitas and Sergio Chapa noted. The number of rigs is already 60% higher than at the same time last year.
With clients such as Antero Resources (NYSE:AR) seeking to further increase production, shares of Enservco rose accordingly.
Imperial Oil (IMPP) +540%
Ultimately, Imperial Oil (NASDAQ:IMPP) completes the top 3 of the most successful artists.
This Canadian-based company is very similar to INDO in its high-cost production. Oil sands are notoriously difficult to extract, and the cancellation of the Keystone XL pipeline means IMMP transportation costs will remain high. The company has generated less than 2.4% return on assets over the past three years.
The renewed interest in Canadian production is a game-changer. On Monday, Alberta Premier Jason Kenney floated the idea of renewing the Keystone XL pipeline. And while the project is unlikely to be built, speculation about the future of Canadian oil has boosted Imperial shares anyway.
…and the sizzling One Stock
There is an obvious problem with buying any of these three companies:
Prices have risen too far, too fast.
INDO shares have already fallen 60% from their retail peak on Tuesday. Its shares will undoubtedly fall further as oil prices moderate.
So which company should people buy?
Summit Channel Partners (NYSE:SMLP).
The master limited partnership is almost as cheap as it gets. The company now trades barely at a $150 million valuation after falling 42% last month.
“Despite the bullish outlook for commodity prices, producer restriction is a recurring theme among public companies and even some private companies,” CEO Heath Deneke said in the earnings call that preceded the collapse.
A ban on Russian gas imports changes all that. As U.S. shale producers ramp up production, Summit’s pipeline network will find new use. Its high financial leverage will also increase returns. The company’s long-term debt of $1.3 billion dwarfs the value of its equity.
Although oil prices will continue to fluctuate, Summit’s cheap starting price will provide investors with a relatively attractive entry point.
Bottom line: SMLP is Moonshot’s best oil choice.
Source: Catalyst Laboratories / Shutterstock.com
Oil companies based in Russia (AKA Grease Fires?)
With Russian oil producers Gazprom (OTCMKTS:OGZPY) and Rosneft (OTCMKTS:OJSCY) down 87% and 67%, respectively, many investors are rightly wondering if it’s time to buy back.
“China is considering buying or increasing its shares in Russian energy and commodities companies,” Bloomberg News reported on Tuesday. “Any deal would aim to boost China’s imports as it steps up its focus on energy and food security.”
But my advice?
Unless you are part of the Chinese Communist Party, it is better to stay away.
On the same day, rating agency Fitch downgraded Russia’s long-term debt to “C”, the second lowest notch. A third of the countries receiving this rating defaulted during the year.
This is a significant issue if you are not a government entity with significant bargaining power. Russian gas giants are priced in rubles for individual investors; a currency crash will create a worthless stock.
There are also practical issues. On Friday, the London Stock Exchange suspended trading in Russian securities. As Western sanctions continue to expand, investors may find themselves holding shares in unsaleable assets.
Finally, there is the question of morality. The past week has already seen a massive exodus of businesses from Russia. Ever since the McRib was launched in my town, I never considered waiting 3 hours for Mickey D’s. Institutional investors will also likely lose patience and boycott Russian stocks.
Speculators expecting a quick and peaceful end to Russia’s invasion of Ukraine could profit heavily from Russian energy stocks. But if history is any guide, it’s best to stay away when currency crises come into play.
How long will the oil windfall last?
Commodity traders have seen this story before…an oil shock followed by a rise and fall.
1973…1979…2003…prices rose rapidly but eventually came down to earth as new wells were drilled.
This time it’s different. Slightly.
Today’s oil shortage is self-imposed, rather than driven by supply (OPEC in the 1970s) or market demand (China in the 2000s).
This led to several differences.
First, the oil majors have been much more disciplined than they were during previous shortages. Much like the mining industry, energy companies have been reluctant to launch multi-billion dollar projects that would only yield results in 5-10 years (the rise of electric vehicles and net zero emissions also influenced this decision) .
Second, geopolitics could absorb Western sanctions. In 2021, China imported 1.6 million barrels per day (BPD) from Russia. If it increases that share of its imports by BPD 8 million, more oil from the Middle East, Brazil and Venezuela will suddenly become available to Western countries.
Finally, swing-producing countries are now driven by politics, not just price. On Monday, US officials from Venezuelan President Nicolás Maduro – a figure widely described as an autocrat – to discuss lifting sanctions in exchange for oil. Similar talks with Saudi Arabia and Iran could also take place.
This means that today’s oil windfall will be shorter than previous peaks (i.e. 1-2 years rather than 5-10), but prices will come back down rather than crashing on a supply surplus. Oil producers have already been burned by over-exploration. They won’t make the same mistake this time.
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As of the date of publication, Tom Yeung had (neither directly nor indirectly) any position in the securities mentioned in this article.
Tom Yeung, CFA, is a Registered Investment Advisor on a mission to simplify the world of investing.
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