After a sharp and painful downturn, oil prices spent the vast majority of 2017 above $50 per barrel. And over the past six months, prices have steadily increased, to the point where Brent crude is getting close to $70. That's a level we haven't seen since 2014. And while there's some risk -- and even some expectation -- that higher production in 2018 will bring prices back down, oil companies are able to make money at far lower prices than they could even two or three years ago.
Even better for investors, the market still hasn't come back for a lot of solid oil stocks. Our contributing investors particularly like Transocean LTD (NYSE:RIG), Hess Corp. (NYSE:HES), and Royal Dutch Shell plc (ADR) (NYSE:RDS-A)(NYSE:RDS-B), and think they're worthy investments to start 2018.
A best-in-class operator trading at fire-sale prices
Jason Hall (Transocean): Since 2014, spending on offshore oil and gas investments has fallen every year. Essentially, every drilling contractor has been forced to scrap and idle vessels to cut costs, and competition for the trickle of new contracts awarded has been fierce, driving dayrates down substantially. This put several big drillers out of business, several more in bankruptcy even now, and saw a significant amount of consolidation, as companies went into survival mode.
This destroyed billions of dollars in wealth, but has also created wonderful opportunities. Right now, Transocean strikes me as an excellent risk-reward investment. Since the oil-price peak in 2014, Transocean has cut its debt and liabilities more than 30%, cut expenses, cleaned up its fleet, and maintained a strong cash hoard to support any cash-flow shortfalls.
This also gave management the ability to act quickly if the right opportunity emerged. That opportunity emerged last year, when Transocean acquired Songa Offshore and its high-spec fleet that already has more than $4 billion in backlog contracts.
As we enter into 2018, the offshore market has started to thaw, and Transocean is leaner than it was at the outset of the downturn, and with a better fleet. It's also far cheaper, with shares trading for 36% of book value. For context, Transocean traded for 1.2 times and higher for much of the past decade -- 3 1/2 times higher than the current valuation. If offshore shows even minimal spending growth from here, Transocean is primed to be a steal.
A turnaround play that's already turning
John Bromels (Hess) With oil prices currently above the $60/barrel mark, there are lots of opportunities for outperformance among oil companies. The problem is, the market has already caught on and has bid up the shares of many of 2017's biggest losers in anticipation of a strong 2018. Luckily for investors, there still may be time to pick up some of these underappreciated gems -- like Hess.
Hess is a bit of a hidden gem among independent oil and gas exploration and production companies. While it went into debt during the oil-price slump of 2014 -- along with practically all of its peers -- the company has kept its debt load manageable, with a debt-to-capital ratio of 33.8%, among the lowest in its peer group. Hess also has $2.5 billion in cash on hand to fund its growth plans, which include embarking on a promising offshore joint venture with ExxonMobil in Guyana, and adding rigs to its leading position in the Bakken Shale.
In spite of all this, Hess's shares fell 23.8% in 2017. And even since oil prices started to rise about six months ago, the company's stock has lagged the performance of its peer group -- as measured by the SPDR S&P 500 Oil & Gas Exploration & Production ETF. But all of that's starting to change. Hess's shares have already jumped 10% this year. That makes January a great time to buy into this surprisingly stable oil company.
Re-positioned and poised to perform
Tyler Crowe (Royal Dutch Shell): It wasn't that long ago that Shell looked like a questionable investment. After acquiring BG Group back in 2015, the company was undergoing a complete corporate restructuring that involved $30 billion in asset sales. For anyone looking at the situation at the time, it was hard to say exactly what kind of performance an investor could expect when so much of the company's future depended on how that restructuring played out.
Today, though, that corporate shakeup is nearly complete, and the company looks like a much stronger company than it has in decades. CEO Ben van Beurden has transformed the company from one that typically lagged its peers in terms of returns on capital employed to a business geared toward consistent double-digit returns and generating gobs of free cash flow.
It hasn't quite reached those levels of return just yet. With international oil prices around $65 a barrel today, there's a good chance we could see those kinds of returns sooner rather than later.
On top of that, it looks like Shell's stock still is trading at a reasonable valuation. When you combine all of these elements together, it would appear that Shell is the best buy among the integrated oil and gas majors. If you're looking for oil stocks in 2018, Royal Dutch Shell could be a good place to start.
Jason Hall owns shares of Royal Dutch Shell (B Shares) and Transocean and has the following options: long January 2019 $15 calls on Transocean. John Bromels has no position in any of the stocks mentioned. Tyler Crowe has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.