Are Oil And Gas Stocks A Buy?

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Taking a look over the latest Green Screens update, I noticed something interesting...

There are a good number of oil and gas stocks screening up for growth and cash flow right now.

So, in this article, we're going to take a broad, "30,000-foot" view of the industry and try to understand why so many stocks from it are passing our Green Screen tests. Could this really be an interesting sector to consider investing in right now?

The 3 Segments Of The Oil and Gas Industry

The oil and natural gas industry have 3 distinct segments.

Upstream, or Exploration and Production (E&P): Firms in this sector do the actual land surveys and geological work to locate commercially viable oil and gas reserves, then spend the capital to construct the drilling and extraction operations needed to get it out of the ground. They earn revenue by selling the extracted material (crude oil or raw gas). Equipment companies are a sub-segment of E&P - these firms sell the drilling and wellhead equipment that is a key part of the extraction operations, but do not extract resources themselves. There are also Services firms that act as contractors to handle particular aspects of the drilling and extraction process.

Midstream: Companies in the midstream segment transport the crude oil and raw gas to storage facilities, where they then handle the sale and transport of it to downstream providers. These firms own assets like tanker ships, railway cars, pipelines, terminals, and storage tank locations. They earn revenue on a contract basis, basically collecting a fee per unit of hydrocarbon transported and stored.

Downstream: Refineries are the main business of the downstream segment. These take the raw materials and refine it into products such as gasoline and diesel for engines, lubricant oils, propane and kerosene for heating, asphalt, and various feedstocks for chemical companies. Revenues are earned on the sale of these end products.

One other term you might see a lot are Integrated oil and gas firms. This simply means that the company controls the entire process, from E&P all the way through to refining and (sometimes) even end-consumer sales. This term usually applies to the "oil majors" like ExxonMobil (XOM) or Chevron (CVX).

Obviously, this is a basic overview of the industry, but it is important to understand the difference between the 3 segments when thinking about the quality of the businesses here.

Eliminating E&P Segment Stocks

The bulk of the Green Screen stocks in the oil and gas patch are from the E&P, or upstream, segment. They are:

Permian Resources (PR)
Talos Energy (TALO)
Chord Energy (CHRD)
Texas Pacific Land (TPL)
Vista Energy (VIST)

My main issue with this segment is that it is highly volatile and dependent on the commodity price for crude oil and natural gas. Due to the Ukraine/Russia war and the subsequent blacklisting of Russian energy, there has been elevated demand for production from other countries. Higher demand combined with elevated oil and gas prices account for much of the growth these companies are seeing right now.

However, we have to ask how sustainable that is. That is a difficult question to answer. If the war is resolved in some manner, it will likely free up supply that is tied up by Russian midstream assets, leading to lower commodity prices and lower revenues for these firms.

Also, the only moat in the E&P business is low cost production. Frankly, I didn't notice any notable historical return on capital numbers in this group that would lead me to believe they have some kind of unique resource that allows lower-than-average production costs.

I'm eliminating all of these stocks from the Watch List consideration, with one notable exception. Texas Pacific Land is not really a true E&P firm, but more of a landowner who leases to E&P companies. That is a much different business model, and TPL has quite attractive long-term ROIC figures. That stock will not be eliminated just yet - we may come back for a deeper dive later.

Additionally, we will eliminate Helix (HLX) and Nabors (NBR). Both of these are drilling equipment and services providers. While their revenues are not directly tied to commodity prices, the overall demand for what they offer ultimately is determined by them. Upstream equipment and services are also very competitive markets with limited moat potential.

Leaving The Rest... For Now

That leaves a handful of other names in the Green Screen. After some abbreviated research, we're going to leave these "open" for now, and may come back to them later. Briefly...

Delek Logistics (DKL) shows as "refining" in the Green Screen, but is actually more of a midstream operation, with their primary business being transportation and storage. Midstream is a interesting business model given its stable contract-based revenue sources, but long-term growth is a question mark.

It is a similar story for DHT Holdings (DHT). This is a midstream firm, however, it is a much smaller operation than Delek, owning just 26 large oil tankers operating out of 3 countries. It owns no pipeline, storage, or terminal assets, which limits its attractiveness at a glance.

Lastly is Equinor (EQNR), the only integrated name on the list. Equinor is actually quite a large firm at a $100 billion market cap, and is about 70% owned by the government of Norway. At a glance, I don't see anything particularly notable about the firm's operating performance compared to U.S. majors like ExxonMobil or Chevron. Equinor's current growth advantage over those two companies is its location in Europe, a continent starved of Russian energy right now. I doubt Equinor would make the cut for the Watch List, but it needs a bit of a deeper dive than this.

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