Rosetta Resources Inc. (NASDAQ:ROSE) and Oasis Petroleum Inc. (NYSE:OAS) are both midcap oil and natural gas E&P companies. Both are good growers. Both operate in prolific oil shale fields in the US. OAS operates primarily in the Bakken with 506,960 net acres; and ROSE operates in the Eagle Ford (about 65,000 net acres) and the Permian (about 60,000 net acres). ROSE has an average analysts' next 5 years EPS growth estimate per annum of 21.77% and OAS has one of 18.89%. ROSE has a PE of 17.68 and an FPE of 13.99. OAS has a PE of 14.27 and an FPE of 13.43. These multiples make ROSE and OAS relative bargains given their five year growth estimates.
When you get an oil spike like the one we are experiencing now due to the uncertainty from both the situations in the Ukraine and Iraq, these companies look even better. The Ukraine situation, especially western sanctions, could lead to the US and the EU seeing Russian oil supplies diminish or become completely cut off. The Iraq War III could lead to virtually all of Iraqi oil being cut off. The various sects in Iraq have hated each other for centuries. Maliki's government was highly Shia discriminatory (for Shias). The other sects don't want to live with this. I don't see a quick resolution; and the oil supply is already starting to be affected. The Beiji refinery in northern Iraq was shut down; and foreign workers there were sent home. It has since come under attack by the ISIL.
It is hard to say what will happen long term, but almost anything could. The Brookings Institute probably has a more educated opinion on this than I do (or than the everyday news does). Follow this link to some of their opinions.
From what the Brookings Institute says and from my own knowledge and experience, I don't see a quick resolution to the problems in Iraq. Rather it seems likely they will escalate into more violence over time. This is bound to involve oil. It is starting to already. There was mortar fire near the Beiji refinery in Northern Iraq; and it is now shut down. The Ukraine/Russia situation is farther on the back burner at this point; but there is a very real possibility of oil supplies to the US and to the EU and natural gas supplies to the EU being cut, if those political entities impose further sanctions on Russia. The sanctions themselves could even include oil or oil companies.
With these factors in mind it is easy to see that US-based oil companies might do much better than they had expected to do over the next year. The more conservative oil and gas people seem to be calling for a 10% to 20% rise in oil prices. Some are calling for a rise to $150/barrel. Still more hawkish pundits are calling for $200/barrel oil (a 100% increase). That would send profits through the roof for many oil companies, especially if they are not too heavily hedged.
OAS averaged 42,856 Boe/d in Q1 2014. It expects to average 43,000 to 46,000 Boe/d in Q2 2014. In Q1 2014 89.4% of this production was oil. The midpoint of the Q2 forecast is 44,500 Boe/d. Using the Q1 2014 percentages, 89.4% of the 44,500 Boe will be oil. This is 39,783 barrels of oil per day of production. OAS has 33,500 Bopd hedged for 1H 2014; but it has only 27,500 Bopd hedged for 2H 2014. For FY2015 that number drops to 19,000 bopd in 1H and 10,000 bopd in 2H. Given that production is expected to increase over that time, this allows a lot of room for OAS to profit if oil continues to spike.
For instance, the production forecast for OAS is 46-50 MBoe/d for FY2014. The midpoint is 48 MBoe/d of which 42,912 bpd are oil if you use the Q1 2014 percentage of 89.4%. This means 15,412 bopd would be unhedged based on the March 31, 2014 amount of hedges. 20% is approximately equivalent to $20/barrel. 183 days * $20/bo * 15,412 bopd would be $56,407,920 in extra revenues in 2H 2014.
Since there would be little if any extra charges involved, virtually all of the $56,407,920 in extra revenues would fall directly to the EBITDA line. Adjusted EBITDA was $239,774,000 in Q1 2014. This would go up normally in the course of 2014. However, using double that (or about $480 million) as a rough baseline, the $56.4 million would represent an extra almost 12% in EBITDA for 2H 2014.
That should allow the stock price to rise over the same period. When you consider that the stock price might already be rising by the 19.30% EPS growth the average analyst is predicting, an extra 12% might engender a 30%+ rise in stock price. Most investors would be very happy with this. When you further consider that OAS has 10.60% short interest as a percentage of the float (as of May 30, 2014), this extra prospective revenue could easily cause a short squeeze. This could cause the rise in the stock price to roughly double. This makes OAS an excellent short term prospect in addition to an excellent longer term prospect.
In addition to increasing production in 2014, OAS is also managing to cut costs and to increase recoveries from oil wells. OAS will complete about 60% of its wells in FY2014 with alternative completion techniques such as Slickwater fracking (20%), proppant optimization (25%), and coil tubing completions (15%). EOG Resources (NYSE:EOG) has seen approximately 40% increases in EUR's (expected ultimate recoveries) by implementing some of these completion schemes. I'm sure OAS is hoping for like results. Thus far OAS has seen positive results.
Also 90% of OAS' drilling in 2014 will be on multi-well pads with increasing pad size. OAS expects 5%-10% cost reductions from this. OAS is also increasing its inventory of drilling locations by drilling the TFS2 and TFS3 in 2014 and 2015. These layers are below the Bakken and the TFS1. OAS is planning about 30 such wells, 15 of these are not currently in its well site inventory. This should mean growth in well sites and growth in reserves. In other words, OAS gives every indication of being a well managed company. It has done well in the past; and it will most likely do well in the future. It is a buy even without Iraq and Ukraine. It is more of a buy with them.
ROSE had total production of 54,293 Boe/d in Q1 2014. Of this 16,146 barrels per day were oil. In the Q1 2014 earnings report ROSE reiterated its full year production guidance of a range of 60 to 65 Mboe/d. This represents 20%-30% year over year growth. The average oil ratio is expected to be approximately 30% in 2014. Total liquids are expected to be 63% of production.
ROSE has only about 9,000 bopd hedged. The midpoint of the guidance is for 62.5 Mboe/d. 30% of this is 18,750 bopd. Therefore ROSE has about 9,750 bopd unhedged for 2014 as of March 31, 2014. If oil prices spike approximately 20% (roughly $20/barrel), then ROSE could earn an extra roughly $35,685,000 in 2H 2014.
There would be little or no added expense to garner this extra revenue. Therefore it would fall virtually directly to ROSE's EBITDA line. Much of it would fall to ROSE's earnings line. Rose reported Q1 2014 net income of $35.2 million (or $0.57 per diluted share). Adjusted net income was $45.6 million (or $0.74 per diluted share), excluding after tax unrealized losses on derivatives of $10.1 million.
The above numbers were actually down from the year ago quarter; but the extra expenses were due mainly to high operating costs due to higher Permian costs. Cash production costs grew 14% compared to the prior quarter on a per unit basis. Part of the extra expenses were the delineation wells in Reeves County. Of course, the Permian holdings are new themselves too. ROSE successfully drilled two Wolfcamp A wells (see table below).
ROSE also participated in five other wells drilled in Reeves County by other operators, including 4 Wolfcamp A wells and one Wolfcamp B/C well. Delineation is costly; but ROSE is adding to its potential drilling locations with each new well. ROSE plans to complete 4 - 8 more operated gross horizontal wells here in Q2 2014. The Wolfcamp is quickly becoming one of the premier plays in the US.
Wolfcamp aside, ROSE is growing rapidly. The charts below shows ROSE's progress in both reserves and production growth.
Considering that ROSE has barely started on the Permian assets, it has huge upside potential in both reserves and in production. This should aid its growth in years ahead. For 2014 ROSE plans to drill and complete about 90-95 gross wells in the Eagle Ford with 4 to 5 rigs. In the Permian it plans to drill and complete 50-55 operated wells with six rigs. Delineation wells take more time and equipment. ROSE expects this to lead to 20%-30% production growth above 2013.
ROSE is also moving to as much pad drilling as possible to save costs. ROSE doesn't seem to be quite as far along in advancing its completion techniques as OAS, but it seems intelligently managed; and I am sure it will get there. That will then be just one more thing that will help it become more profitable. It is a buy without the problems in the Ukraine and Iraq. With those problems, it is a stronger buy.
ROSE is also highly shorted at 9.30% of its float (as of May 30, 2014). If investors were already going to bid ROSE up by the 21.77% of its average analysts' next 5 years EPS growth estimate per annum, then they might bid it up by another 20% or so due to spiking oil prices that stay high. Plus the momentum/HFT traders seem sure to engineer short squeezes. These could take the price up almost double that. ROSE could see a 50%+ rise in stock price within the next year. Of course if oil prices starting falling again at some point, investors would probably want to sell for the near term. Then they could buy again at a later date and a lower price. The same would apply to an OAS investment. ROSE is a buy.
The two year chart of OAS provides some technical direction for this trade.
The slow stochastic sub chart shows that OAS is at overbought levels. The main chart shows that OAS is in a jagged, but steady uptrend. The recent news about Iraq should only help this continue.
The two year chart of ROSE provides some technical direction for this trade.
The slow stochastic sub chart of ROSE shows that ROSE is overbought. The main chart shows that ROSE's stock price has been going sideways for almost two years. The recent increase in expenditures (due mostly to the new Permian assets) cut into EPS. This undoubtedly curbed the upside of the stock. However, as the relatively good results comes in from the Permian, the opinion of investors will likely change.
Good news about new wells in the new area may cause some short squeezes. The momentum/HFT traders may drive this stock up on that alone. When you add a possible huge gift to profits due to higher oil prices, ROSE's stock price may really take off this year. The short interest will help momentum/HFT traders push the stock upward. ROSE's stock price could have 30% to 50% or more upside in 2014.
Both ROSE and OAS are solid long term buys. For the shorter term they may look even better. I should also mention that ROSE's credit was upgraded on May 21, 2013 to Ba3 from B1 (the corporate family rating) by Moody's. Its probability of default rating was also upgraded to Ba3-PD from B1-PD by Moody's. The credit upgrade should help ROSE manage its expenses more easily. It also makes investors feel just that little bit better about the company.
CAPS rates both OAS and ROSE five stars (a strong buy). They seem likely to make investors money. I just rate them buys; but I note that they both have the possible oil spike and short interest short squeezes going for them besides great growth.
NOTE: Some of the fundamental financial information above is from Yahoo Finance.
Good Luck Trading.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in OAS, ROSE over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.