Oil has finally found a strong bull in Savita Subramanian, commodity strategist at BofA Merrill Lynch, who believes oil will rally to $54 a barrel by this year-end and continue its march higher to touch $69 a barrel by June of next year.
The commodity team led by Savita has upgraded the energy sector to outperform. The analysts have added Devon Energy to the firm's US 1 list and raised ratings on four other stocks.
"Oil production continues to fall as global oil & gas investment has been cut by nearly $300bn (41%) and rig counts have dropped by 37% since the 2014 peak. In contrast, low oil prices continue to drive healthy demand growth, putting the oil market on pace to see its biggest supply-demand deficit since 2011," the report noted.
They estimate the shortfall to last through 2020, if prices remain below $80 a barrel.
The firm has raised the outlook for the energy sector from marketweight to overweight considering the following factors.
1. They have found that historically, the energy sector outperforms the S&P 500 almost every time oil rallies by more than 25%. The only aberration was the massive stock market rally from the lows of 2009.
2. The sector remains out of favor with investors-it's the fourth most underweighted sector, according to their estimates.
3. The energy stocks makeup less than 7% of the S&P 500, and every time this has happened in the past, the sector beat the market over the next three years.
List of stocks that have been upgraded
1. Marathon Oil Corp. (NYSE: MRO) to a buy from neutral, with a price target of $21, which is higher than the $18 consensus of various analysts. The new target price implies a gain of more than 33% from the current price of $15.7.
2. Noble Corporation PLC (NYSE: NE) from underweight to neutral. However, the target price of the stock is unchanged at $7.5, which is below the consensus target price of $8. The stock closed at $6.39 hitting a new multi-year low.
3. Patterson-UTI Energy Inc. (NASDAQ: PTEN) to neutral from underperform. The new target price on the stock is $22, whereas the consensus target price is also the same. The stock closed at $19.96.
4. Sasol LTD. (NYSE: SSL) to a buy from an earlier rating of neutral. While the consensus target price of the stock is $32.09, the stock closed the day at $27.71.
5. Devon Energy Corp. (NYSE: DVN) makes it to the US 1 list of top ideas for Merrill.
Notwithstanding, the valuations of the energy sector at 40 times its forward price-to-earnings (P/E) is more than double to the S&P 500's forward P/E of 17, according to Yardeni Research.
Though the Merrill Lynch report agrees that "energy looks expensive on depressed earnings," they believe that "higher oil prices should drive higher earnings estimates. Investors are still underweight the sector and the sector's weight in the S&P 500 has fallen to historically bullish levels".
The whole report is based on the assumption that prices will continue to rise from the current levels. These projections are in stark contrast to that of Goldman Sachs, which believes that oil is stuck in a range of $45 to $50 till mid-2017 and Morgan Stanley, which has forecast crude to slip to $35 a barrel and to average only $40 a barrel in the fourth quarter of this year.
The oil market continues to remain volatile with a lot of uncertainties, hence, traders should be careful with any long positions in oil, especially when it is approaching its resistance levels.
By Rakesh Upadhyay for Oilprice.com
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Rakesh Upadhyay is a writer for US-based Divergente LLC consulting firm. More
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