Oil is starting to shine again as the fundamentals driving the price of the commodity look good. This surely is good news for oil exploration and production (E&P) companies which have endured an oversupplied crude market long enough.

Fundamentals Driving Crude

Like any other commodity, the price of crude is determined by its market demand and supply. Since last June – when oil was trading around $100 per barrel – we saw a prolonged plunge in crude. This was primarily owing to plentiful North American shale supplies when nobody seemed interested in buying, sluggish growth in China and a dull European economy.

The fundamentals, however, are improving. On the supply front, crude inventory as per the Energy Information Administration (EIA) – which provides official energy statistics from the U.S. government – has been falling for three consecutive weeks. Numerically, the inventory got reduced by 8,747 thousand barrels over the last three weeks.

But the real booster should be felt on the demand side. The peak summer driving season in the U.S. – started officially this past Memorial Day weekend – should fuel up crude consumption. According to the American Automobile Association (AAA) and IHS Global Insight, about 37.2 million travelers were forecast to have traveled by air and road during the weekend. If the prediction is to be believed, then this Memorial Day weekend might have been the busiest in a decade, with the highest travel volume since 2005.

Moreover, we have seen Asian demand for crude increasing. As per Energy Aspects − an independent research consultancy firm in U.K. – notwithstanding slowing economy in China, the country’s crude import touched a record 7.4 million barrels per day in April. Additionally, according to the Ministry of Finance, customs-cleared oil imports in Japan hiked 9.1% from last April to 3.62 million barrels per day in April 2015.

The improving fundamentals − as reflected in growing demand and lower supply – are reflected in the recent West Texas Intermediate (WTI) crude price of $59.72 per barrel, up significantly from the six-year low mark of $43.88 per barrel in Mar 2015.

Who Will Gain?

Of course, the upstream energy players will benefit first. Since they sell crude in the market to the refiners, the E&P companies will be able to sell the commodity at a higher price and hence can generate considerable cash flows for their shareholders.

If we look deeper, even when crude was dirt cheap and the E&P companies were struggling, Saudi Arabia couldn’t care less. This is because the country – the largest exporter of crude with 16% of the total proved reserves in the world, as per the EIA – needs to spend only $5–$6 per barrel to get oil out of the ground. As a result, although oil trickled to a six-year low level of $43.88 per barrel, it still got much bang for the buck.  

On the other hand, the U.S. suffered mostly because the cost of producing shale oil is relatively expensive. Most importantly, the life span of shale oil well is considerably short and the production from these wells is also tougher without a regular flow of investment.  

3 Prominent Picks

Given that the primary business of upstream players is likely to outperform the broader U.S. equity market owing to the improving crude price, it would be a wise decision to add top-ranked stocks − in this space – to your portfolio. Some such stocks include:

LRR Energy LP (LRE - Snapshot Report)

Houston, TX-based LRR Energy engages in the exploration and development of oil and gas resources in North America. The properties where the partnership has interest in are situated in New Mexico, Texas and Oklahoma.

On Apr 30, 2015, the partnership reported first-quarter earnings of 45 cents per unit, which surpassed the Zacks Consensus Estimate of 24 cents. Higher production supported the results.

Presently, the stock – with year-to-date (YTD) return of 14% − sports a Zacks Rank #1 (Strong Buy), implying that it will significantly outperform the broader U.S. equity market over the next one to three months.

Sanchez Energy Corp. (SN - Snapshot Report)

Houston, TX-based Sanchez Energy is an upstream energy firm, which involves primarily in exploration and development of oil and natural gas resources. Its onshore unconventional assets are located in the Eagle Ford Shale in South Texas.

Although the company’s first-quarter earnings missed the Zacks Consensus Estimate, the stock – with an impressive YTD return of 19.3% − currently carries a Zacks Rank #2 (Buy), also implying that it will outperform the broader U.S. equity market over the next one to three months.

GeoPark Limited (GPRK - Snapshot Report)

Hamilton, Bermuda-based GeoPark explores, develops and produces oil and gas resources located in Colombia, Chile, Argentina and Brazil.

For the trailing four quarters, the company’s average earnings surprise came at 72.31%. Moreover, GeoPark’s YTD return is 8.4%. The stock presently carries a Zacks Rank #2.

Bottom Line

Although we have highlighted the key points that are pushing oil prices up, the crude market remains oversupplied. So investors interested to play this space must necessarily keep a close tab on it. Needless to say, if the positive forces are sustained and the commodity touches the $100 per barrel mark, nothing will be as gainful as an oil-rich portfolio of an investor.