Top Oil Picks as Prices Plunge

Dave Meats: WTI crude prices plunged 8% yesterday, extending a route that has wiped off almost a third of the benchmark's value in about six weeks. For the first time since October 2017, front month futures closed in line with our $55 a barrel fair value estimate.

The decline reflects the realization that U.S. sanctions on Iran might not leave a big supply deficit going into 2019 after all, despite initial fears to the contrary. In fact, a handful of OPEC producers and Russia are now talking about the need for further supply cuts to prevent another glut. That's a complete reversal of sentiment in a fairly short period. How things evolve from here is still unclear, as there are several critical unknowns.

The Iranian sanctions have been in effect for only about a week and a half now, so we won't know what the full impact on Iranian production is for at least another month. While Venezuela production has been leveling out in the last couple of months, the economic situation there continues to deteriorate, so those volumes are anything but stable. The same applies to Nigeria, Libya, and Angola.

On the demand side, we still don't think the market is thinking enough about price elasticity, and is assigning too little risk for the potential escalation of the U.S.-China tariff war. Depending on where these variables shake out, it's still possible to have either under supply or oversupply next year.

The message from us has not changed. Avoid making a directional bet on near-term prices, and focus instead on the firms that can thrive in our midcycle forecast, at $55 a barrel for WTI. That's set by the marginal cost of shale production. The top picks in the E&P space are Diamondback Energy, Pioneer Natural Resources, and Continental Resources, and among the integrateds, Shell and Total are the standouts.