The Best Way to Capitalize on Higher Oil Prices

Enerplus in a position to capitalize on rising crude oil and natural gas prices

Jun 25, 2014 at 10:57AM

Enerplus Corporation (NYSE:ERF) continues to impress. Since recovering in 2013, the stock has largely been on an upward movement, gaining around 76% from the beginning of 2013 to date.

The chart below gives clearer insight.

Erf Stock

Source: Yahoo!

Enerplus has not only favored growth investors but income investors, too, have something to smile about. Despite the current dividend being less than what we had in the 2010-2013 timeframe and before, the current 4.20% yield is markedly better than what the broader market presents.

The only question that persists is whether or not Enerplus will carry on in its encouraging trend. But Enerplus' production mix plays perfectly into the current and expected price movements in natural gas and crude oil, a factor that will sustain its rally for the foreseeable future.

Sustainable production mix
Enerplus is targeting a balanced production mix for 2014, with 52% of overall output comprising natural gas, 44% constituting crude oil, and the remaining 4% going to liquids, according to company filings. This targeted production mix will allow Enerplus to skillfully navigate the pricing vagaries that both crude oil and natural gas present.

Crude oil, which Enerplus produces from the Bakken, will present great margins for Enerplus. The West Texas Intermediate and the Brent benchmarks are currently hovering close to their 2014 highs following political unrest and sectarian violence in Iraq, the second largest OPEC producer after Saudi Arabia. WTI, for instance, is somewhere around $107 per barrel. Higher crude prices allow producers to increase their margins, at least if costs remain unchanged or increase at a lower rate relative to the price increments. Moreover, Libya, which is also crucial to global supply, is also riding the wave of uncertainty, indicating that the geopolitical drivers of high oil prices will continue to persist. Libya's overall production in April was at a multiyear low of 238,000 barrels per day compared with 1.4 mbpd in 2012.

While critics may argue that gains in crude oil prices due to political risks are temporary, which I agree with, the argument for higher crude oil prices not only in the mid term, but in the long term, is supported by other stronger factors. The International Energy Agency (IEA) in a new report says that the energy sector will require $48 trillion in investments through 2035 to meet the world's energy needs. Such a mammoth investment bill will certainly be reflected in prices of commodities such as crude oil. This argument is heightened by the fact that; even at current high prices, producers' margins are still largely unattractive due to the ever increasing costs of tackling challenging geology.

Natural gas prices, too, are expected to increase, partly explaining why Enerplus has shifted most of its 2014 focus to the commodity. At the beginning of 2014, natural gas rigs in the U.S. totaled 372. However, by June 10, the number declined to 310, according to data provided by Baker Hughes. Interestingly, this decline represents nothing out of the ordinary and is in fact a pullout from a wider trend. In late 2011, natural gas rigs reached a high of 900 -- almost triple the number we have now. The decline in the number of rigs means that less and less natural gas is being produced, partly because of the low price environment that has persisted since the shale boom.

However, as overall U.S. natural gas production output continues to sharply decline, economics of demand and supply will play out, leading to upward pressure on natural gas prices. Already, prices have started inching upward. In the first quarter of 2014, natural gas prices averaged $4.72 per MMBtu compared with the $3.73 per MMBtu for 2013. And even now, high prices still persist at the $4.7 per MMBtu range, showing that the winter demand in the first quarter of 2014, when natural gas prices averaged $4.72 per MMBtu, was not the key driver for higher natural gas prices, but rather, contracted supply was.

In a position to capitalize
While higher prices present opportunities for the entire upstream segment, Enerplus is uniquely positioned to capitalize on the situation. First, Enerplus has a high number of undeveloped resources that would make business sense developing in a high-price environment. It has already started development on some of these properties and in consideration of this, expects its average daily production this year to range between 96,000-100,000 barrels of oil equivalent, compared with 94,167 barrels of oil equivalent in the fourth quarter of fiscal 2014.

Increased output, coupled with relatively high price points, will translate into high margin growth. This argument is strengthened by the fact that Enerplus uses a technique called downspacing, which places wells close together to increase efficiency. Moreover, it has been able to cut costs by 11.1% since 2012 and is guiding for an additional 3% cut in 2014. This laudable level of efficiency will allow it to maximize profits.

Similarly, Enerplus in 2011 changed from being a royalty trust to a regular corporation, meaning that it started paying taxes. Although becoming a regular corporation prompted a reduction in dividends in order to adjust to the new realities of tax payments, the overall situation presents a great opportunity for long-term investors. Paying taxes has prompted Enerplus to court frugality, making it place its dividend payout at the lowest possible point in order to secure sustainable cash flows. As profit margins increase on the back of higher prices for crude oil and natural gas, Enerplus -- owing to its frugality -- will have a lot of room to continually increase its dividends. This will ultimately reward income investors handsomely. Moreover, the share price will continue tracking upward, making Enerplus a choice pick for growth investors as well.

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Lennox Yieke has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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