This Week in Energy: The Bull Case in the Near-Term

Energy investors were definitely happy this week after OPEC finally set aside its differences and agreed to limit production to 32.5 million-to-33 million barrels per day, down from the current range of 33.2 million-to-33.4 million barrels per day. Although talk and execution are two different things (as history has shown many times before), WTI crude futures rallied to $48 per barrel and the United States Oil Fund LP rallied by over 7% this week.

In this article, we’ll see what the smart money thinks of five oil companies, SM Energy Co (NYSE:SM), Pioneer Natural Resources (NYSE:PXD), Devon Energy Corp (NYSE:DVN), Freeport-McMoRan Inc (NYSE:FCX), and Oasis Petroleum Inc. (NYSE:OAS) and analyze the bull case for shale drillers going forward.

While there are many metrics that investors can assess in the investment process, the hedge fund sentiment is something that is often overlooked. However, hedge funds and other institutional investors allocate significant resources while making their bets and their long-term focus makes them the perfect investors to emulate. This is supported by our research, which determined that following the small-cap stocks that hedge funds are collectively bullish on can help a smaller investor to beat the S&P 500 by around 95 basis points per month (see the details here).

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SM Energy Co (NYSE:SM), Devon Energy Corp (NYSE:DVN), and Pioneer Natural Resources (NYSE:PXD) all had a great week courtesy of OPEC’s surprise decision to agree to cut production on Wednesday, as shares of the first two companies rallied by around 11.5%, while shares of Pioneer rose by 5.7% during the week.

Investors have been buying the three stocks because a successful OPEC intervention will lead to higher crude prices, all else being equal. According to energy analysts at Goldman Sachs, the OPEC deal could add $7-$10 per barrel to oil prices in the first half of 2017. In addition, the threat of OPEC intervention has likely put a floor on oil prices of about $40 per barrel and will likely dissuade many shorts from attempting any bear raids. Finally, it seems that Saudi Arabia does want higher prices, as it needs to ensure a good environment for the eventual Saudi Aramco IPO next year.

In terms of company-specific effects, lower OPEC production means that the three Texas shale drillers could ramp up production to fill the gap. Higher crude prices will also help the three increase their cash flows and improve their balance sheets in the meantime. Meanwhile, positive M&A and capital markets activity cannot be ruled out either.

Of the 749 hedge funds that we track which filed 13Fs for the June quarter, the smart money was most bullish on Pioneer Natural Resources (NYSE:PXD) as 74 funds were long the stock at the end of June. Devon Energy Corp (NYSE:DVN) was a close second, as our database shows that the number of funds long Devon rose by three during the second quarter to 61 at the end of June. Meanwhile, 20 funds were long SM Energy Co (NYSE:SM) on June 30.

On the next page, we’ll continue examining the bullish case for oil while taking a closer look at Freeport-McMoRan and Oasis Petroleum.

Perhaps due to the fact that it agreed to sell its deepwater Gulf of Mexico assets before the OPEC news and perhaps because copper futures haven’t exactly been lights-out bullish, Freeport-McMoRan Inc (NYSE:FCX) shares only rallied by 2.1% on the week. Although the price action has been disappointing, the stock has considerable upside if crude prices can make their way to $60 per barrel or higher. Freeport still has some interesting oil and gas assets that will increase in value if energy prices recover. Carl Icahn‘s Icahn Capital, which has cut its stake in some other energy companies this quarter for ‘tax planning purposes’, has remained steadfast in Freeport-McMoRan Inc (NYSE:FCX) according to publicly-available data. Icahn’s fund held 104 million shares of the company at the end of June.

Although the Bakken isn’t the most cost-competitive place to produce shale oil in America, Bakken producer Oasis Petroleum Inc. (NYSE:OAS) was certainly one of the big winners this week, as shares of the company surged by 25%. Given that over one-in-five shares in Oasis’ float was short, OPEC’s surprise announcement likely precipitated a short squeeze. Although it isn’t exactly competitive while WTI is at $40-to-$45 per barrel, Oasis does become very competitive at $50-$55 per barrel or higher, as that level is generally above the company’s break-even price. 33 funds in our system were long Oasis Petroleum Inc. (NYSE:OAS) at the end of June, up by four funds from the end of March.

Are you bullish on oil in the near-term? Will OPEC deliver on its promises? Let us know in the comments.

Disclosure: None