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Upstream Energy Stocks Dip Into Attractive Territory

Diamondback Energy and Continental Resources look especially appealing.

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Dave Meats: Upstream energy stocks have seen sharp declines in the last couple of weeks, and many are now trading in attractive territory. Sentiment has turned sour on the sector, which has shown extreme volatility recently. These stocks are highly correlated to oil prices, and WTI crude has fluctuated from a high of $76 to a low of $43 in the last year alone. The negativity was exacerbated by the announcement by President Trump that the U.S. will further escalate the Sino-U.S. trade war by adding 10% tariffs to another $300 million dollars worth of U.S. imports from China, which means all Chinese imports will now face import duties. In retaliation, the Chinese government allowed the renminbi exchange rate to slip below 7 for the first time since 2008, making U.S. imports and dollar-denominated crude more expensive in China. But the market's getting carried away. In total, the U.S. will be taxing $600 billion worth of Chinese imports, which is still a small fraction of global trade, valued at least $17 trillion. So, while there is still scope for further downside, we think the impact on global GDP, and indirectly on crude demand, will be modest based on the actions announced to date.

Likewise, the negative reaction to Concho Resources' earnings release also looks overdone. The firm reported weak well results from a 23-well project, testing narrow well spacing. So the test was a failure, but the solution is easy: The firm can revert back to the wider spacing it was using before. At that wider spacing level, we still see multiple decades of low-cost inventory for Concho in the Permian Basin, where it operates. Nevertheless, the slump in shares was severe and contagious--almost every other U.S. shale firm saw a steep decline at the same time. We think this creates a buying opportunity for our favorite low-cost, narrow-moat-rated shale producers. In particular, we highlight Diamondback Energy, ticker FANG, and Continental Resources, ticker CLR. Both have a strong cost advantage due to their high-quality shale acreage, and neither is likely to run out of Tier 1 inventory in the next 10 years.

Dave Meats does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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