Time to Start Looking at Small Cap Oil Stocks

Time to Start Looking at Small Cap Oil Stocks

In any downtrend, it can be difficult to know exactly when the market is carving out its bottom and is ready to start sending prices higher once again.  But last year’s drop in oil markets has generated some interesting buying opportunities in oil stocks -- and the time to start buying could be right now.  The major trends in the sector will, of course, depend heavily on underlying oil price.  But if the recent upside reversal in West Texas Intermediate (WTI) crude is any indication of things to come, it is time to start looking at the stocks (both large cap and small cap) that are best positioned to benefit.  

From a fundamental perspective, there are a few different reasons to believe that we are at the beginning of a bull market in oil.  With oil inventories falling to their lowest levels in months and manufacturing productivity showing strong improvements in emerging markets (particularly in China), supply and demand dynamics favor significant upside potential in crude in the coming quarters.  Positive expectations in these areas can also be supported by stronger GDP performances seen in the US, helping make the case for rising demand in developed markets.

For those with a long term perspective, it will be critical to monitor developments in emerging Asia as China has already become the world’s largest importer of oil products and is projected to spend nearly $500 billion in annual oil imports by 2020.  This is well above the US record of $335 billion spent annually and so it will make sense for investors to start gaining exposure to the companies that are in the best position to capitalize on rising demand in emerging Asia.

Trends and Time Horizons

From a long-term perspective, the expected trends are relatively clear.  Over the next half-decade, oil imports in China could approach 10 million barrels per day as manufacturing productivity and infrastructure building continues to support demand for energy products.  But most of the difference in the production and consumption of oil will need to be made up with imports, in trends that can be seen in the chart below:

Stock Choices

“Given the current framework,” said Rick Bartlett, markets analyst at CornerTrader, “it makes sense to start looking at energy stocks to buy -- both from short-term and long-term perspectives.”  One of the most common approaches here is to simply by ETFs tied to the price of oil, with the United States Oil Fund LP ETF (NYSE: USO) being a primary example.  But for those looking to gain exposure to oil producers that will be able to cushion any potential volatility in commodities futures markets, large caps stocks like Cabot Oil & Gas (COG) and EOG Resources (NYSE: EOG) present some interesting options.  

Both stocks are now trading at attractive valuations and recently announced project planning shows that some strong growth prospects are now in the pipeline at both companies.  Over the next three years, EOG Resources expects to generate oil and liquids growth rates that could reach double-digit territory.  The stock is trading at valuations that are below seven times the company’s discretionary cash flow, which is well below the levels seen in EOG’s main competitors.

Small Cap Choices : Octagon 88

But given the broader trends seen in emerging markets, it makes sense to start looking at small cap opportunities that are positioned to capitalize on both developed and developing markets.  The best selection in this area could just be Octagon 88 (OTCQB:OCTX), which has a production pipeline that makes it an attractive choice for potential acquisitions for outlets in emerging Asia.  A development-stage oil and gas company, Octagon 88’s light and conventional heavy oil assets are centered mostly in Canada’s oil-rich areas.  

Key areas to watch can be found in Octagon’s Red Earth Area, which should strengthen the company’s competitive position and boost productivity in coming quarters.  These are outlets that will likely be touted highly by emerging Asia’s rising petrochemical industry.  So, for investors looking for ways to benefit from the region’s long-term trends and rising energy demand, OCTX is a solid buy at current levels.