Largest OPEC Producers Agree to Production Freeze. Will It Last?

02/16/2016 8:50 am EST

Focus: STOCKS

Michael Berger

President & Founder, Technical420.com

After meeting in Qatar, Saudi Arabia and Russia—the world's two largest crude producers—agreed to freeze oil production output at January levels, and while Michael Berger of Technical420.com does not expect to see the price of oil and gas rebound until the back half of 2016, he highlights one company he feels possesses the right traits in a weak market.

After months of speculation, Saudi Arabia's oil minister announced that he has come to an agreement with his Russian counterpart. Saudi Arabia and Russia, the world's two largest crude producers, agreed to freeze oil production output at January levels after meeting in Qatar.

Qatar and Venezuela also agreed to participate in this deal which is conditional on other nations agreeing to participate. Saudi Arabia wants Iran and Iraq to be part of the agreement or they believe that the agreement is not worth much.

Easier Said Than Done

When OPEC met in December, Iran said it would not cut oil production after international sanctions were lifted on the country last month. Earlier this week, Iran sent its first Europe-bound crude cargo in four years.

During January, Iraq produced a record amount of oil (4.35 million barrels a day) according to the International Energy Agency. While we hope that Iran and Iraq are on board with this plan, we think it will be tough to get them to agree after the lifting of sanctions on Iran and as Iraq still recovers from years of conflict.

Operators Continue to Cut Capital Spending

After hearing a number of energy companies announce earnings, one of the biggest talking points has been the level of capital spending. The low oil and gas price environment, combined with an almost non-existent debt market (for non-investment grade companies) has forced companies to reduce spending severely.

Although we do not expect to see the price of oil and gas rebound until the back half of 2016 ($55 a barrel by yearend), we believe the risk:reward profile is moving to the upside. We continue to prefer companies that have strong balance sheets, premium acreage, healthy debt-adjusted production growth, and seasoned management teams who can find value in a weak market.

Concho Resources Possesses the Right Traits

Concho Resources, Inc. (CXO) is our favorite energy stock going into earnings season. CXO reports earnings on February 24 and over the last several years, CXO has been able to beat production and cost expectations on a consistent basis. We do not expect this theme to end during 2016. In fact, we believe that CXO will highlight its best-in-class operational capabilities.

Looking forward to 2016, CXO set preliminary guidance of flat production on a year-over-year basis with $1.4 billion in spending. Given CXO's ability to scale based on pricing and our expectations of an oil recovery during the back half of 2016, we expect capital expenditures to trend higher than expected during the second half of the year.

Financial Flexibility Will Stimulate Inorganic Growth

The weak oil and gas price environment has made financial flexibility more important than ever. CXO has a solid balance sheet with a net debt/EBITDA of 1.7x. CXO also recently completed a $794 million equity offering to fund acquisitions. This raise provided the company with around $500 million in borrowing capacity.

To date, CXO has acquired around 25,000 net bolt-on acres in the Delaware basin, Midland basin, and New Mexico Shelf. Management plans to continue making opportunistic acquisitions during 2016. CXO has a reputation of acquiring high quality acreage from companies who do not have enough capital to execute.

Valuation Is Attractive

Last week, oil prices traded at a new 12-year low and approached $26 a barrel as the return of Iranian exports threaten to prolong and worsen the current global surplus. During the last six months, CXO has fallen by more than 20% and shares are down 6.1% during 2016. Shares have fallen 40% from its highs in July 2014 (traded as high as $148.30) and we think the risk:reward profile is attractive at current levels.

Michael Berger, Founder and President, Technical420.com

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