Oil Drop Creates Buying Opportunities

by: Best Credit

To start 2014, oil prices have taken another downturn. After reversing sharply from $100 per barrel, market valuations in West Texas Intermediate (WTI) crude have fallen to the low $90s in a move that suggests any bullish attempt at a rally will be met with active selling. But when we look at these markets from a longer-term perspective, the bullish argument remains intact. Into 2020, energy demand in emerging markets is expected to show drastic growth. Already overtaking the U.S. as the world's largest oil importer, China is expected to spend roughly $500 billion on oil exports by the end of the decade. To gain some comparative perspective, the U.S. spent only $335 billion at its peak annual levels. So, it is clear at this stage that Chinese demand will help to protect long-term positions in oil producers -- and that the recent declines should be viewed as a buying opportunity.

Frankly speaking, these higher energy costs will not create the most encouraging scenario for China's economy. But these long-term trends will create clear positives for oil futures and the companies that produce the commodity. China's oil imports are expected to rise from 2.5 million barrels per day in 2005 to 9.2 million barrels per day by 2020. So, while the total daily oil consumption in the U.S. still far outpaces what is seen in China (18.6 million daily barrels versus China's 10.9 million), it is clear that investors positioned in oil markets will need to continue to focus more specifically on emerging markets in order to gauge the broader trends in place.

Stocks to Watch

More immediately, it makes sense to start looking for way to play the weakness we are seeing in oil markets. A popular option in these types of scenarios is to base positions on the oil ETFs, like the United States Oil Fund LP ETF (NYSEARCA:USO), but there are strong opportunities to be found in the oil producers as well. Two of the most stable large-cap choices can be found in Cabot Oil & Gas (NYSE:COG) and EOG Resources (NYSE:EOG), which have become relatively inexpensive and show strong potential for growth in coming years. EOG, in particular, expects to produce double-digit growth rates in oil and liquids for the next three years, and the company possesses an impressive portfolio of resources when compared to key competitors like Continental Resources (NYSE:CLR) or Devon Energy (NYSE:DVN). Over the last 12 months, EOG has produced $7 billion in discretionary cash flow. At current valuations, EOG is trading at less than 7 times its discretionary cash flow, and when we take these numbers along with its expectations for growth into 2017, it is easy to make a bullish case for buying the stock.

Growth Focus

For investors with more of a growth focus and broader time horizons that are looking to play off the expected trends in China and other emerging markets, another selection can be found in Octagon 88 (OTCPK:OCTX), which is a development-stage oil and gas company with light and conventional heavy oil assets centered in Alberta, Canada. Recent progress in its Red Earth Area strengthened its production position, and the company was recently approached by a large Chinese conglomerate about a possible acquisition. This means that Octagon 88 is well-positioned to benefit from the longer-term trends in emerging markets in ways that are more direct than many of its peers.

The company has been on the better end of a lot of positive news recently, as Octagon 88 has started to drill and become an actual oil producer. And with GDP and manufacturing data out of China showing signs of stabilization and improvement, asset demand in 2014 should continue to benefit. For those looking for ways to establish long-term positioning in these trends, it makes sense to consider some smaller cap options in addition to the more commonly watched companies, given the fact that there are important arguments supporting the bullish outlook for limited downside into 2020.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.