After falling to historic lows this spring, oil markets are on track to reverse pandemic-fueled losses by the first half of next year, analysts at Bank of America said in a report last week.
The recovery — which is set to push the price of Brent crude, the international benchmark, to $60 a barrel — is driven by a global drop in output, largely through an OPEC agreement to curb production, and a steady increase in fuel demand, the analysts said.
But while the fall in oil prices may prove temporary, its impact on the US oil-and-gas industry will endure, according to a more recent Bank of America report published Monday.
"It's hard to overstate the change we believe has taken place in the energy sector in the past six months," the report said.
And those changes impact energy investing, the bank added.
Investors have overlooked the longterm impacts of an oil market meltdown, it said, which is causing US companies to abandon "growth as a strategy" and marks the end of a business model "that broke the US oils." Instead, companies are focusing on generating cash.
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"This has the potential to reset the US oils to its legacy promise of what the sector can represent: reintroducing investors to an investment case that offers moderate growth, competitive with the broader market, and allows direct participation in a cyclical recovery in oil prices," they wrote.
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'The worst earnings season in a generation'
The US oil and gas industry is known for unbridled growth enabled by "perpetual spending on a hamster wheel," the analysts said.
Growth helped carry the country to energy dominance — but, as they point out, it came at a cost. It "underpinned amongst the worst returns of any sector in the broader market over the past five years," they said.
Then the pandemic struck, causing oil prices, on which these companies depend, to fall by as much as 70% by April. Today, a barrel of Brent is down about 33% since the start of the year, at about $44 a barrel.
Oil companies have lost billions in the months since.
In the second quarter, which Bank of America called "the worst earnings season in a generation" for US oil companies, majors Chevron and Shell, alone, for example, posted a combined loss of more than $26 billion.
While the quarter reflects a temporary crash in oil prices, it could be the most consequential quarter in a decade, the analysts said.
"It is serving as the catalyst that forces a reality check on the business models that have decimated market confidence in the US oils," they wrote, mentioning similar sentiments shared by executives in the exploration and production (E&P) side of the industry.
"The traditional E&P growth model of the past is not viable going forward," Devon Energy's CEO, David Hager, told investors in August.
The future of oil markets
The collapse in oil markets combined with a growing focus among investors on sustainability has created a complete "cocktail of disincentives to own energy" stocks, the bank said.
Yet, the analysts believe that, on the other side of the coronavirus pandemic, the US oil-and-gas sector will be more investible than any time in the last decade.
Months of cheap oil has transformed E&Ps, driving a new mandate of moderate growth "that is competitive with the broader industrial sector, but leveraged to a cyclical recovery," the bank said.
It is "reintroducing investors to the reason this sector existed in the first place," the analysts added.
Plus, oil prices are recovering. There's an "accelerated rebalancing of global oil markets," the bank said, which is set to drive the price of Brent to $60 a barrel by the first half of 2021. At the start of this year, well before the coronavirus became a pandemic, a barrel was selling for about $68.
Taken altogether, Bank of America says it sees "significant value" for many American oil companies. So where is it placing its bets?
Bank of America's top stock picks
The analysts looked for companies with plenty of cash and limited debt that are set to rebound along with oil prices.
Their top picks include Occidental Petroleum, Exxon Mobil, Hess Corporation, Apache Corporation, Devon Energy, Pioneer Natural Resources, and Concho Resources.
Occidental, they said, is a "controversial stock" and the timing of its acquisition of Anadarko Petroleum was unfortunate. But they added that it has a large number of assets, an updated board, and, generally, is poised to ride the recovery in oil prices.
Exxon (XOM), which made deep cuts to capital spending, is similarly set for growth, they said.
"In our view, XOM will be the only oil major to emerge from the latest downturn with capacity for sustainable dividend growth intact," the analysts said.
Devon, Pioneer, and Concho, on the other hand, have three important traits in common, the bank said. They are heavily hedged in 2020, meaning low oil prices don't weigh them down as much, they have valuable oil-and-gas assets, and they are equipped to pare back spending should oil prices remain low or sink down further.