These 2 energy stocks could be boosted by falling prices

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Energy stocks aren’t getting much help from oil prices this year, but they could get an unusual boost: deflation.

Oil prices have been stuck between around $68 and $75 a barrel since the start of May, and even Saudi Arabia’s surprise announcement following the June 4 OPEC+ meeting hasn’t helped. couldn’t change that. The Saudis have said they will cut crude oil production by 1 million barrels a day in July, on top of already agreed cuts made by OPEC+ members, which have been extended through 2024. WTI Crude , the US benchmark, gained 1.1% this week through Thursday to just $72.53.

However, there is little Saudi Arabia can do to support the price. This is especially true when China’s post-pandemic economic reopening collapses and Russia must sell oil at any price to fund its war effort, says Edward Yardeni, president of Yardeni Research. A stable oil price could be the best outcome Saudi Arabia can hope for. “[They] could slow the decline in oil prices,” writes Yardeni.

Stable oil prices may still be enough to generate plenty of revenue for producers, even if there is no repeat of oil gains in 2022. Last year’s boom was accompanied by a surge production costs, driven by rising prices for labour, drilling equipment, diesel and other fuels, and chemicals and raw materials used to extract and process oil and gas gas. When commodity prices soar, producers are happy to pay rather than risk missing out on the windfall. Where there is not this rising tide to lift all producers, there is a deeper examination of business costs.

And oil stocks have come under intense scrutiny this year. Not only is energy the worst performing sector in the

S&P 500,
down 8.5% this year, it’s also one of the cheapest. THE

Energy Select Sector SPDR
the exchange-traded fund (ticker: XLE) is only earning 10.4 times expected earnings over the coming year, compared to 18.6 times for the overall index.

There is good news for US producers: their production costs are expected to reverse somewhat over the coming year as hype continues to die down, inflation subsides and new developments remain limited. The prices of tubes and pipes used in the production and transportation of oil are already down more than 20% over the past year. The costs of various oil services, which reset periodically when contracts are renewed, tend to fall. Fracking machine and sand prices are holding steady for now, but look set to drop as availability improves.

Citigroup analyst Scott Gruber expects overall costs to drop about 10% for U.S. shale drillers in 2024. The impact on individual companies will depend on when their contracts are renewed. Gruber points out

Devon Energy

(DVN) and

Marathon oil

(MRO) among the main potential beneficiaries, with the majority of their generally shorter-term drilling contracts being renewed in the second half of the year.

That won’t stop revenues from falling – oil prices are down 40% from their peak last summer, after all. But it can help profit margins. Analyst consensus predicts an 18% drop in Devon’s sales in 2023 and another 9% drop in 2024, but Wall Street sees its earnings before interest, taxes, depreciation and amortization, or Ebitda, margin drop to 59% in 2024 against 51% this year. That could help drive 5% EBITDA growth next year despite falling revenue, analysts said.

Not all producers will benefit from such a significant boost, including

Diamondback Energy

(FANG) and

EOG Resources

(EOG), says Gruber. “FANG excelled during the inflationary period which, with some [electric fracking] contracts…probably equates to a relatively smaller deflation benefit,” he writes.

The benefit to oil and gas producers’ profit margins will not reverse the overall strength of the decline in the value of the commodity they sell. But it’s an underrated force in Wall Street’s most unloved sector this year.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com