(By Mani) Crude oil prices have surged by more than 20 percent in the last six weeks after a 30 percent drop from their March levels. Similarly, US natural gas prices, which hit a low of $1.90 per million cubic feet (mcf) in April, their lowest level in more than 10 years, have surged by more than 50 percent since then.
This rebound in oil and gas prices lifted the stocks in recent weeks by more than 15 percent, 12 percent for the majors, 25 percent for the refiners and 15 percent for the large E&P companies. Year to-date, however, most oil and gas stocks have lagged the S&P 500, which has gained almost 12 percent. The only exceptions were refining stocks, which have gained more than 40 percent on average.
Oil and gas stocks usually outperform the S&P 500 during periods of rising oil and gas prices and lag during periods of declining prices. The stock performance is usually driven by the outlook for oil and gas prices, not the current price levels.
"We expect crude oil prices to remain inflated by fears of potential supply disruptions and excessive speculation, as we believe the highest cost production is profitable at oil prices 20% below current levels," Oppenheimer analyst Fadel Gheit said in a client note.
In addition, oil supplies are growing as technology continues to unlock new, unconventional resources, while the demand growth rate is moderating as a result of a weak economic outlook and improving energy efficiency.
Even with the recent surge, US natural gas prices are still 80 percent lower than crude oil prices on an energy equivalent basis. However, prices above $4/mcf would open up curtailed supplies and pull gas prices lower again. Barring a surge in US gas demand, gas prices could remain depressed.
"The industry's shifting away from dry gas drilling to oil and liquids-rich plays should reduce the gas oversupply and support higher prices," Gheit added.
Meanwhile, US refiners are benefiting from wide crude differentials, cheap, natural gas, growing export markets, and declining environmental spending. The trends are expected to continue for many years.
"Refining stocks have outperformed all other energy sectors and the S&P 500 YTD and in the last two years. But, despite the strong performance, the stocks remain reasonably priced at 7.7x P/E and 5.4x P/CF," the analyst noted.
Currently, oil stocks are discounting lower crude oil prices, while gas stocks are discounting higher natural gas prices. Aside from oil and gas prices, Anadarko Petroleum Corp. (NYSE:APC) and BP plc (NYSE:BP) would benefit from reaching legal settlements, while additional asset sales could benefit Chesapeake Energy Corp. (NYSE:CHK) and ConocoPhillips (NYSE:COP).
"Additional share buybacks and dividend increases could help Valero Energy (NYSE:VLO) and Devon Energy (NYSE:DVN). The most undervalued stocks on P/E and P/CF multiples are Apache Corp. (NYSE:APA) and Hess Corp. (NYSE:HES)," Gheit said.
On the economic front, rising oil and gas prices only benefit oil and gas producers and their suppliers, but erode consumer confidence and curtail spending, which negatively impacts the economy.