StockBeat: The Sun Also Rises on Oil and Gas Stocks

By Geoffrey Smith

Investing.com -- As European stock markets took fright Friday at the sight of U.S. and Asian markets selling off, there was at least one sector still enjoying a strong end to a strong week.

Oil and gas stocks, which surged on Thursday after the Organization of Petroleum Exporting Countries surprisingly kept a tight cap on its output quotas for April, were still enjoying their moment in the sun, many hitting their highest levels in over a year as analysts revised up their crude price targets for 2021. Citigroup (NYSE:C) analysts now expect Brent crude prices to hit $70 a barrel by the end of the month, while Goldman Sachs (NYSE:GS) analysts expect it to hit $80 by the third quarter.

The Stoxx Oil and Gas index rose 0.5% to its highest level since February 2020, when the start of the pandemic knocked the bottom out of the oil market as travel demand collapsed.

Gains throughout the sector broadened as markets recovered from the overnight shock of bond market volatility that followed another relaxed take on the inflation outlook from Federal Reserve Chairman Jerome Powell. Even at the end of a week that has seen most names rally by between 5% and 10%, there appeared to be little pressure to consolidate. Royal Dutch Shell (NYSE:RDSa) stock rose 1.6%, and is now trading above where it was when it announced its fateful dividend 'reset' last spring, while BP (NYSE:BP) stock rose 2.0% and Equinor (NYSE:EQNR) stock rose 2.9%, the last of the three hitting its highest in 13 months along with Italy's Eni (NYSE:E).

There were even bigger 'mean reversion' trades in smaller producers and, conspicuously, in oilfield services stocks, as investors priced out the risk of any further cut to capital spending against a more favorable pricing environment. U.K. independent Tullow Oil (LON:TLW) rose another 8%, bringing its gains for the year-to-date to 68%. But long-neglected names such as Petrofac (LON:PFC), Saipem (OTC:SAPMY), Hunting (OTC:HNTIY) and Tenaris (NYSE:TS) made solid gains too.

The case for the upstream producers is relatively straightforward, especially since Shell and others have signaled that they don't intend to increase production from here on, but rather just to pocket the higher cash flow and use it to reduce debt and keep shareholders happy. Rising bond yields aren't great for majors who have borrowed to get themselves through the last year, but the forces driving yields higher are also ensuring the majors can service that debt more easily.

The case for the services companies, however, is a little more nuanced. The 'OPEC+' decision on Thursday was effectively a bet on the fact that non-OPEC supply - particularly U.S. shale - won't come back in a hurry even if the cartel does squeeze supply for longer. In other words, a bet that any pick-up in business for oilfield services will be at best modest. That's important for the likes of Austria's Schoeller-Bleckmann (VIE:SBOE), which does most of its business in the U.S.

The OPEC+ decision is also an admission, implicitly, that the bloc doesn't yet believe fully in the demand recovery story, for good reason: international air travel is still on its knees, and from India to Italy and Texas, Covid-19 cases have stopped falling as governments have bowed to pressure to reopen.

However, that's unlikely to bother anyone in the industry in the short term. The clouds have lifted, and it's time to enjoy the sunshine.

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