Oil prices are on the upswing, which should provide oil stocks with plenty of fuel. However, there is a tendency among investors to buy well-known names during an upturn simply because it is the easiest route. While that could work just fine, we think investors are missing out on some potential unsung heroes that have tremendous upside: Denbury Resources (DNR), Parsley Energy (PE), and Phillips 66 Partners (PSXP). Here's why these names should be on your radar.
Doing oil production differently
Tyler Crowe (Denbury Resources): Shale drilling in the United States has emerged as a prominent force in the oil and gas industry. This is a resource that was barely economical at $90 a barrel five years ago but one that is very economical at $60 a barrel today. That's a lot of progress in a short time. What's unchanged with shale drilling, though, are the steep decline rates that require a lot of capital spending to maintain production. This isn't a problem when oil prices are high or rising, but we have seen how much this can be an issue when oil prices drop.
Contrast that with exploration and production company Denbury Resources, which uses a production technique that injects CO2 into mature wells and can recover much of what was left behind from other production techniques. According to management's presentations, Denbury can extract as much as 17% of the original oil in place in a reservoir.
Image source: Denbury Resources investor presentation.
This extraction technique could unlock billions of barrels of oil in the U.S. that were previously considered unobtainable, and the best part is we know where it all is. That makes Denbury's exploration rather easy compared to companies that need to find new sources. It's also important to consider that the decline rates for CO2 injection are much lower than those for shale drilling. This means that the company's capital spending to maintain its current production is considerably less than shale's. That trait can come in handy when oil prices plunge.
Like shale, Denbury has done a lot to reduce its own costs as well. Today, the company's total cash costs is $33.33 per barrel, which translates to a decent return of $50 per barrel of oil. With a stock that is trading at 1.5 times tangible book value -- after several billion in asset writedowns, mind you -- Denbury looks pretty cheap and could reward shareholders.
Perfectly positioned in the Permian
Matt DiLallo (Parsley Energy): While most of the oil and gas industry has been in the doldrums, the Permian Basin has been rocking with activity. Fueled by hydrocarbon-rich rocks, adequate infrastructure, and falling extraction costs, producers have been able to earn lucrative drilling returns even as prices crashed. That has enabled little-known Parsley Energy to rapidly expand, positioning it for even more explosive growth as commodity prices improve.
One of the reasons Parsley Energy is not a name most investors know is that it has only been a public company for 10 quarters. However, over that time, it has managed to grow production by a remarkable 17% compound quarterly growth rate during one of the worst oil market downturns in decades. Fueling that growth is its impressive low-cost position in the Permian Basin, where its wells can generate 65% to 90% returns at current commodity prices.
Parsley has strategically invested billions of dollars during the downturn to acquire additional acreage in the Permian. As a result, it has amassed more than 150,000 net acres in the region, which holds more than 4,500 high-return drilling locations, providing the company with decades of growth at its current drilling pace. In fact, for 2017, Parsley expects to grow production by another 58%.
At some point, investors are going to wake up and realize that this is one remarkable oil growth stock.
Image source: Getty Images.
This small MLP may be a better income investment than its big oil parent
Jason Hall (Phillips 66 Partners): While Phillips 66 (PSX -0.66%) is one of the largest and best-known oil and gas companies out there, few investors know that the company's master limited partnership, Phillips 66 Partners, could be an even better income-growth investment.
Since creating its MLP in late 2013, Phillips 66 has been steadily shifting its midstream assets to Phillips 66 Partners, while the partnership itself has raised substantial capital to invest in new projects. The combination of these drop-down assets from the parent, and the new projects, is creating substantial predictable cash flows, a lot of which are being returned to investors.
At recent prices, Phillips 66 Partners yielded 3.6% and sports a 1.48 times distribution coverage ratio, even with a 5% increase in its quarterly payout. Since it first started paying a dividend, Phillips 66 Partners has grown that dividend by 35% on an annualized basis. And while it's not reasonable to expect that high rate to continue, it's far more likely than not that the partnership will be able to keep increasing its payout at a high rate, even while retaining enough cash flows to help pay for growth and asset maintenance.
If it's a solid income-growth investment you're looking for, Phillips 66 Partners may be a better pick than its parent company. Don't let it fly under your radar.
