Oil Rebound Suggests Upside in Energy Stocks

NEW YORK (BestCredit.Net) -- Oil prices closed 2013 with markets under heavy pressure, but we are starting to see a turning point in commodities valuations that could be a harbinger of good things to come.  Prices in West Texas Intermediate crude have risen to their highest levels in two weeks, driven largely by results in economic data.  The numbers suggest positive growth signals for the US and its position as the world's biggest consumer of oil.  

Some of the most recent examples can be seen in home construction figures, which just finished their best year since the 2007 sector peak.  Additionally, the December industrial production showed gains for the fifth straight month, and employment figures have shown steady long-term improvements (with the exception of the downside non-farm payrolls miss seen earlier in January).  This creates a bullish scenario for oil from the demand perspective, but there are reasons for bullishness on the supply side, as well.

Conspiring Bullish Events  

In the U.S., crude inventories have fallen to their lowest levels since Q1 2012 (with crude stockpiles falling to 350 million barrels last week).  Crude supplies have dropped by more than 40 million barrels in the last two months, which is the biggest decline seen in more than 30 years.  An economic picture that is progressing at a time when oil supplies are dropping suggests that we could be seeing a bottom in energy markets.  This creates a supportive scenario for ETFs like the United States Oil Fund (USO) but there is a strong case to be made for the oil stocks that have been sold-off in recent months, as well.   

Stocks Choices to Consider

For those looking to buy into what could be a burgeoning bullish trend in energy markets, consider both large- and small-cap options that will be well-positioned to withstand potential volatility as we move forward into 2014.  This is important because we could start to see changes in markets as the Federal Reserve starts to cut back on its quantitative easing stimulus programs.  

In large caps, two highly stable stocks can be found in EOG Resources  (EOG) and Cabot Oil & Gas  (COG), which are currently showing inexpensive valuations and rising growth forecasts over the next three years.  

Corporate guidance for EOG is showing projections for oil and liquids growth rates that could reach double-digit territory over this period, and key industry peers like Devon Energy  (DVN) and Continental Resources  (CLR) possess resource portfolios that pale in comparison.  From a valuation standpoint, we have seen a massive generation of discretionary cash flow at EOG.  The stock currently trades at seven times discretionary cash flow, which creates strong potential for long-term buy positions that can withstand temporary drops in the oil price.

Small Cap Selection

Long-term positioning, however, lends itself well to those willing to take a look at smaller cap alternatives, and one of the best options can be found in Octagon 88 (OTCQB:OCTX).  As a development-stage oil and gas company, OCTX puts most of its focus on its Canadian light and conventional heavy oil assets.  One of its most important resources can be seen in the Red Earth Area project, which has contributed to the company's ramped-up production numbers.  Recent news of a potential acquisition by a Chinese conglomerate suggests that the company still has plenty of upside and will be in a better position to capitalize on rising demand expectations in emerging Asian markets. If we do see a Chinese buy-out, OCTX will be able to benefit from this demand in a more direct fashion, and this supports the long-term outlook for the stock.  

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.