4 Oil Stocks to Buy for Crude’s Latest Surge - Barron's

Mizuho says oil stocks are ripe for a rebound.

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Investors have been stressed about the possibility that oil demand has already peaked and it could be all downhill from here. The pandemic has reduced demand for oil as fewer people commute to work, and a shift to renewables will soon reduce demand for oil on a longer-term basis. BP released long-term projections last year that indicate demand may never fully recover.

But one analyst says the doom-and-gloom may be overstated. In fact, Mizuho analyst Daniel Boyd is betting that oil companies—which have cut their drilling substantially in response to the pandemic—are actually producing too little oil now and a shortage is coming. That could lead to higher prices than the market is currently anticipating, and it could boost some stocks.

“We do not expect oil demand to peak for at least a decade and see risk of supply shortages post-2025,” Boyd writes. “In other words, the fear of demand loss is leading to the actual loss of supply and sustainably higher prices.”

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Boyd’s top picks are ConocoPhillips (ticker: COP), which he expects to give investors a 29% total return, and Occidental Petroleum (OXY), which he thinks could return 30%. Boyd also has Buy ratings on Chevron (CVX) and Royal Dutch Shell (RDS.A). His top picks “combine high quality assets with commodity price leverage,” he writes.

Some of this is already reflected in the market—oil prices have risen about 10% in just the past two weeks, and most stocks are higher, too.

Boyd thinks that oil companies have pulled back on supply so aggressively that they’ll soon push the market into undersupply—after years of persistent oversupply. The number of rigs drilling for oil in the U.S. is still down 60% from pre-pandemic levels. The industry is expected to reinvest just 70 to 80% of its cash flow from operations back into producing oil, down from 100% to 140% in the recent past, the analyst writes.

The pullback comes as oil demand is likely to rebound sharply this year given the rollout of Covid-19 vaccines. The decline in air travel is the leading cause of weak oil demand. But people around the world will soon be getting back on planes to make up for all the travel they missed out in 2020, Boyd projects.

“We expect pent-up demand for air travel to drive a ‘V’ shaped recovery in demand. Jet fuel is only 8% of demand but represents 40-50% of the decline,” he writes. China is already as example of this, he says: “China oil demand is already up 5.8% year over year; faster than the 5-year Compound annual growth rate of 4.9% as evidence of pent-up demand.”

Blackstone Group’s Byron Wien and Joe Zidle wrote that oil’s resurgence would be one of 10 “surprises” for 2021, but it’s quickly becoming conventional wisdom.

That’s why it is also worth considering a more bearish scenario. Among the factors that could change this equation is Iran increasing production, Boyd notes. The country, whose oil exports have been hobbled by sanctions, has about 2 million barrels a day of spare capacity. A new Iran nuclear arms deal under President Joe Biden, for instance, could lead to all that oil coming back on the market and shifting the supply-demand balance to the downside.

Write to Avi Salzman at avi.salzman@barrons.com

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