With the current earnings cycle drawing to a close and very few S&P 500 members left to report their financial results, we now have a clearer picture of the current trends.

It is a well-documented fact that the ‘Oils/Energy’ sector has been one of the weakest in the past several quarters. Nonetheless, this space has seen certain favorable developments in recent times – the OPEC’s decision to curb production, improvement in crude price, and increase in U.S. rig count to name a few – that might turn the tide for this beleaguered space. Let’s take a look at the performance of Oil/Energy sector in the July-September period and pick stocks that are expected to beat their earnings estimates when they release their quarterly results. Going by our Earnings Preview report dated Nov 4, 2016, about 94.4% of the Oil/Energy companies have already reported with a beat ratio of 73.5%.

Before going into the details we will first analyze how crude and natural gas prices behaved. We shall also see how these commodity prices influenced the fate of the energy players.

Oil & Natural Gas Pricing in Q3

The pricing scenario for natural gas was much better in the third quarter, both on a sequential and an annualized basis. However, oil prices were weaker than the July-September quarter of 2016. Despite the persistent weakness in crude, the commodity price improved significantly from the mid-February lows. The improvement in commodity prices is undoubtedly favorable for upstream energy players as these firms would now be able to continue exploration and production activities by hiring more drillers.     

This is evidenced by the substantial increase in the U.S. rig count in recent times as indicated by Baker Hughes Inc.’s (BHI) – the company’s data issued since 1944 is an important yardstick for energy service providers in gauging the overall business environment of the oil and gas industry – rig count for Sep 2016. In the U.S., the total number of rigs increased from the Aug 2016 count owing to a rise in the number of land rigs.

Developments on this front should be favorable for upstream energy players in terms of improved production and prices. The midstream energy players, on the other hand, are poised to gain in the third quarter as the oversupplied commodity market might increase the need for storage and transportation of oil and gas.

How to Make the Right Picks?

Given the plethora of issues faced by the Oils/Energy sector, picking the most investment-worthy stock is undoubtedly a daunting task. This is where the Zacks methodology come to the rescue. One could narrow down the list using the positive Earnings ESP as a guide, along with a favorable Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold).

Earnings ESP is our proprietary methodology for identifying stocks that have high chances of surprising in their next earnings announcement. It shows the percentage difference between the Most Accurate estimate and the Zacks Consensus Estimate.

Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%. 

Our Choices

San Antonio, TX-based Abraxas Petroleum Corp. (AXAS - Free Report) is involved in exploitation and development of oil and gas resources in the U.S. Abraxas Petroleum’s is likely to beat on third-quarter earnings as it has an Earnings ESP of +25.00% and a Zacks Rank #3. The company is expected to report third-quarter results before the opening bell on Nov 14.

Lonestar Resources US Inc. (LONE - Free Report) , based in Fort Worth, TX, is an upstream energy firm engaged in activities like acquisition and development of unconventional oil and gas resources in the U.S. The company will likely release third-quarter results on Nov 18. We expect Lonestar Resources to surpass expectations as it has an Earnings ESP of +16.67% and a Zacks Rank #2. 

Dallas, TX-based Energy Transfer Partners LP (ETP - Free Report) is an MLP engaged primarily in the gathering, processing, storage and transportation of natural gas through a network of pipelines spanning some 24,000 miles. The partnership will report third-quarter results on Nov 9, after the closing bell. We believe the partnership will beat our estimates given its Zacks Rank #3 and Earnings ESP of +11.54%.