Why Oil Will Recover In A Big Way And Who Will Benefit The Most

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Includes: BHI, CSIQ, X
by: Adam Alvarez

Summary

Drop in oil prices has led to a significant decline in the number of U.S. oil rigs.

Lower oil prices will lead to a noticeable rise in long term demand.

By allowing oil prices to temporarily sink, OPEC is being granted more power to control long term prices.

Higher beta stocks on track for the sharpest gains once oil prices stabilize.

With oil prices dipping below support at $30 and a further influx of oil arriving from Iran, there might seem little reason to believe that an eventual turnaround is in sight. Still, even though OPEC might not be cutting production, that doesn't mean the balance between supply and demand won't eventually swing the other way. In fact, the increased supply could actually provide a long term benefit for both OPEC and oil prices.

Why Will Oil Prices Recover?

  • More U.S. Oil Rigs are Shutting Down: The U.S. reached a peak of 1,609 oil rigs in October of 2014. In the first two weeks of this year, after the number has dropped by another 21 rigs, the grand total now stands at a mere 515. As the low prices have made drilling financially unpractical, OPEC is being granted more and more control over prices.
  • Lower Prices Stymie Innovation: While maybe better for the environment and while sucking less gas, hybrids and electric cars don't come cheap. In a time of lower fuel prices, it doesn't make much economic sense to splurge on something that isn't really saving anything. In fact, some are turning back to the old gas-guzzlers certain to eventually fuel a rally in oil prices.
  • Price Drop Hasn't Really Benefited Economy: The drop in fuel prices hasn't exactly led to an increase in spending elsewhere. With retail sales posting their weakest year since 2009, the efforts to pump more fuel at home are becoming increasingly disadvantageous.
  • OPEC Sees Long Term Benefit of Temporarily Low Prices: OPEC may still have a firm grasp on prices, but with more supply elsewhere and the threat of weakening demand, these countries realize the bind they're in. Allowing prices to surge would only fuel the rush to lower demand and leave these nations in economic turmoil. By lowering prices and putting a cap on both drilling and innovation elsewhere around the world, OPEC is allowing their short term pain to turn into a long term gain.

Companies to Benefit the Most From a Recovery in Oil Prices

While low beta stocks such as Exxon Mobil (NYSE:XOM) have been spared some of the most intense selling crushing other oil-sensitive names, its been the more historically volatile stocks that have taken the biggest hit. With oil possibly finding a bottom, it should therefore be such names that enjoy the quickest reversal.

  • U.S. Steel: While shares of rival Nucor (NYSE:NUE) have fallen 30 percent from their 52-week high, that pales in comparison to the 74 percent drop suffered by the perennially more volatile U.S. Steel (NYSE:X). As the subsequent fall in oil and the effect on energy has led to a 38 percent drop in the price of hot-rolled steel coil, the company has seen earnings losses that have missed expectations over the past three quarters. With fourth quarter earnings expected to show another loss of $0.81 and projections calling for losses over the first three quarters of this year, any sustained rise in oil would be welcomed news for shareholders. With a short interest at nearly 40 percent and shares finding recent support at the $6.50 level, that gain for long term investors could also prove significant.

U.S. Steel Has Found Support at the $6.50 Level

  • Baker Hughes: In the four trading days in December prior to shares of Baker Hughes (NYSE:BHI) losing support at the $50 level, volume registered at over 6.2 million shares per day or more than double the average of 3.1 million. Since falling to newfound support at the $40 level on January 12, volume has been below average at around 2.9 million. With short interest at a meager two percent and those wishing to sell already clearly out of the stock, some stability in shares should be expected. With the stock down over 43 percent since its high in May and full year 2016 earnings expected to show year-over-year growth of 32 percent, that stability might soon turn into an eventual rebound.

The Stock Has Found Support at the $40 Level

  • Canadian Solar: The connection between solar companies and oil has been more and more rejected in recent months and years. However, low oil prices can still diminish the appeal of solar even if only from a state of mind standpoint. As solar stocks such as Canadian Solar (NASDAQ:CSIQ) hit their 52 week highs in May, the same time oil peaked, these companies and their shares have suffered a similar downhill fate. Still, unlike competitors such as SolarCity (NASDAQ:SCTY) and SunEdison (NYSE:SUNE) which have posted significant losses in earnings, Canadian Solar is expecting full year 2016 earnings of $2.27 leaving the stock on track for a P/E ratio of well under 10. With shares currently sporting a beta of 3.3 and while off more than 53 percent from their 52 week high, any appreciation in oil prices could leave shares with significant gains.

With a High Beta and Strong Earnings, Canadian Solar Could Offer Solid Gains

For those who believe oil prices will continue to sink, it's important to remember that OPEC would never let that happen. Also, with Iranian supply now flooding the market, its nations like the U.S. which have begun drilling more feverishly in recent years that will ultimately feel the pinch. When that happens, oil prices will have nowhere to go but up.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in X over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.