8 Ways to Play Energy Stocks in Risky Global Markets (Update 1)

Updated to reflect Stifel Nicolaus commentary on short squeeze energy stocks

NEW YORK (TheStreet) -- With the continuing threat of a euro zone collapse, new economic data that casts a shadow over the U.S. economic recovery -- Bill Clinton says we are already in a recession, Warren Buffett hems and haws and blames it all on Europe -- and the prospect that growth slows in China, energy stock investors have been put in a corner, or is it a good time to selectively add energy stocks?

On the one hand, energy stocks have been roiled by a recent drop in oil and gas prices near 2012 lows. Yet, it's a sector that had already been among the most beaten up in the equities universe before another onset of global macro panic. In particular, the natural gas heavy exploration and production companies are priced by the market with at least a hint, if not healthy dose, of bankruptcy risk. Natural gas has rebounded since hitting a decade-low below $2 earlier this year, and in fact, the natural gas spot market pricing has been one of the gainers in energy sector trading over the past few months.

Year-to-date, the S&P 500 energy sector is down more than 7%, versus an S&P 500 gain of just under 2%. The oil service stock sector is down close to 6%. Even among the "safe" dividend rich blue-chips, Exxon Mobil and Chevron have fallen 7% this year while GE has gained 4%.

Energy stocks have been the proverbial falling knife an investor doesn't want to try catching, but falling commodity prices may actually be an opportunity for stock investors in oil and gas giants and other companies whose earnings are tied to the sector. Here are some of the top energy stock ideas from Wall Street analysts:

1. Bank of America
Focus: the balance of risk in U.S. large cap energy names has shifted relative to weaker crude oil pricing.

Bank of America cut its oil price outlook on Wednesday as a result of global economic risks, but still offered some energy stock plays that may hold up amid continued economic deterioration and could contain value in an upturn.

"As contagion spreads from banking woes to economic growth expectations, oil prices are falling rapidly. In addition to weakening demand in Europe, growth in the emerging markets and the US is softer than anticipated... supply has surprised to the upside recently," writes Bank of America energy analyst Francisco Blanch in a Wednesday note cutting the firm's estimate of oil prices in the second half of 2012.

Blanch now sees West Texas Intermediate at $97 a barrel and North Sea Brent at $106 a barrel in the remainder of 2012, below previous expectations of $107 and $117 previously. "It is important to highlight that our numbers build in a substantial policy response to the ongoing economic woes in Europe and beyond," Blanch adds.

But in spite of Bank of America's concerns about the global economy and lower commodity price expectations, the firms actually sees a present drop in WTI to $85.80 a barrel and a drop in North Sea Brent below $100 a barrel as a potential opportunity.

"For those invested in energy we believe the balance of risk has improved materially," writes the firm's oil and gas equity analyst Douglas Leggate in a Wednesday note. "We believe the balance of risk for the large cap US oils has improved materially with implied oil prices 'discounted' nearing $60. As a minimum we believe a selective look at renewed Energy exposure is warranted."

Leggate recommends Hess ( HES), Marathon Oil ( MRO), Anadarko Petroleum ( APC) and Occidental Petroleum ( OXY) as oil and gas sector top picks. Hess, which is trading within 10% of its 2008 lows amid execution problems and weak earnings, is Leggate's top pick.

For Hess, Leggate sees the company's production in the Bakken shale, in addition to previously announced asset sales and commodity price hedging as catalysts for the stock. "We believe the recent sale of HES 16% stake in Scheihallion with associated value we estimate at ~$400m may be just the start," he writes.

Meanwhile, Leggate calculates that Marathon Oil is trading at one of the lowest multiples of large cap energy names. "In our view this is not justified and with the separation for the refining and marketing business complete, 2012 sees the first full year as an independent where management can fully dedicate upstream cash flow to E&P activities." Anadarko Petroleum may benefit from lower than expected legacy legal liability from its Tronox unit and Occidental Petroleum provides the sector's most defensive value play, Leggate adds.

2. Stifel Nicolaus
Focus: energy stock short squeeze

Comstock Resources ( CRK), Magnum Hunter Resources ( MHR), EXCO Resources ( XCO), Petroquest Energy ( PQ) and Bill Barrett ( BBG) are all natural gas-tied stocks that could rise on a short squeeze, notes Sifel analyst Amir Arif in a June 6 note. "Non-commercial net short positions have been reducing in nat gas despite the recent drop in nat gas prices," writes Arif.

A possible short squeeze lines up with Stifel's belief that while natural gas is still oversupplied relative to the firm's outlook on supply and demand, it is less so, potentially benefiting commodity prices. "The storage constraints this fall should provide a damper on natural gas and a good entry point at sometime between 2Q earnings and the fall." Other stocks that could benefit from declining natural gas inventories and a sector short squeeze include Southwestern Energy and Cabot Oil & Gas ( COG).

3. Guggenheim Securities
Focus: independent E&Ps

In a Tuesday note to clients, Guggenheim Securities analyst Rob Cordray highlights Anadarko Petroleum and Noble Energy ( NBL) as top picks across the exploration and production sector, while Devon Energy ( DVN) still stands to benefit from the shift it made from deepwater oil to unconventional drilling assets after selling its Gulf of Mexico holdings to BP more than two years ago. Nevertheless, Cordray sees Devon Energy's Canadian assets as particularly exposed to oil price volatility.

4. Credit Suisse
Focus: finding the "go-to" natural gas stock, with a liquids tilt

For natural gas stock investors who expect a recovery in gas prices from near-decade lows but are weary of the murky outlook for Chesapeake Energy ( CHK), Credit Suisse analyst Arun Jayaram suggests that Southwestern Energy ( SWN) is a "go-to" stock when natural gas prices turn because of its strong balance sheet and its existing base of production in the Fayetteville and Marcellus shale's.

Jayaram, who upgraded Southwestern Energy from underperform to neutral on Wednesday concedes that the company is already richly valued compared to some embattled peers; however, he expects shale assets to support 8% production growth through 2015 amid a long-term rebound in gas prices.

"Recent sharp declines in conventional activity and more permanent shifts in producer economics that favor liquids plays could bring about a faster reset in the gas market than implied by the gas futures strip," notes Jayaram, who boosted his price target for Southwestern Energy to $29 from $25.

For those who want to play the energy sector but are weary of direct exposure to commodity prices, Credit Suisse's recent addition of Pennsylvania-based utility PPL Corporation ( PPL) in its "Better than Bonds" portfolio may prove to be a defensive energy play worth watching. The basket was created in 2010 with the premise that bond investors may move into low-beta, high-yield stocks given low returns on Treasuries. Previously, Credit Suisse held Con Ed ( ED) in the portfolio.

5. Deutsche Bank
Focus: natural gas stocks as a defensive trade

As drillers like Southwestern catch the interest of some, Carl Icahn's recent activist investment in Chesapeake Energy has boosted the natural gas sector's biggest 2012 stock story. In Wednesday trading, Chesapeake Energy rose over 5% on Bloomberg reports that the company is considering selling its minority stake in its Chesapeake Midstream Partners ( CHKM) pipeline unit for $4 billion.

Now some are targeting natural gas producers as a way to defend against the possibility negative macroeconomic data continues to hit energy prices.

"We see the recent outperformance of natural gas stocks as a defensive trade within the group (vs. downside risks to oil)," writes Deutsche Bank oil and gas equity analyst Stephen Richardson in a Wednesday note to clients. Still, Richardson concedes its a risky proposition. "While we see tighter balances in 2013 and beyond for the commodity, we expect the stocks to remain volatile due to little support from earnings momentum even in a $4/mmbtu environment in 2013," he adds.

Although natural gas has been hit by an oversupply in the U.S. and a persistent inventory build, Richardson notes that a drop in natural gas drilling rigs may not cut inventories. "A massive step change in upstream operating efficiency has challenged the rigs to production relationship," he writes, citing calculations that although rigs are down 31% production declines have been "slow to materialize."

6. ITG Investment Research
Focus: big exposure to the "shale promise" stocks

At a conference last week, ITG Investment Research highlighted that a backlog of undrilled shale gas wells, productivity gains in unconventional drilling and the release of associated natural gas from oil drilling rigs is causing a "shadow inventory" equal to roughly 8% of total U.S. natural gas production.

Still, the firm notes Pioneer Natural Resources ( PXD), EOG Resources ( EOG), El Paso ( EP), Approach Resources ( AREX) and Laredo Petroleum ( LPI) as horizontal drillers with the biggest exposure to promising shale's in the Midland Basin.

7. Sterne Agee
Focus: natural gas hedging strategies as the best defensive plays

Sterne Agee analyst Tim Rezven highlights Pioneer Resources and Energen ( EGN) as two gas drillers with gas hedging contracts that could limit their earnings downside were commodity prices to fall. "We believe they are attractive defensive holdings for investors seeking exposure to the industry who remain bearish on the outlook for commodity prices, despite the recent pullback in oil prices," he writes in a June 1 report that gives both companies buy ratings.

8. Dahlman Rose
Focus: oil service stocks have to bottom out at some point, and that point is approaching

For those trying to catch a drilling boom instead of an oil or gas commodity price surge, Dahlman Rose analyst James Crandall notes that oil service company stock prices may be approaching "trough valuations" after a 33% drop in the Oil Service Sector Index ( OSX) since March 2011. Crandall highlights Baker Hughes ( BHI), Haliburton ( HAL), National Oilwell Varco ( NOV) and Weatherford ( WFT) as large cap oil service companies that are attractively valued.

For more on oil and gas M&A, see 5 energy deals not to be forgotten in 2012 and Chesapeake Energy's flurry of asset sales.

-- Written by Antoine Gara in New York

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