NEW YORK ( TheStreet) -- If you believe oil prices are inevitably headed higher next year, energy analysts at Credit Suisse Securities Research and Will Riley, a portfolio manager, think they know the best way to play the move.
They recommend buying energy companies with enough balance sheet leverage to look scary -- so that they have fallen more than the safer names -- but not enough debt to make them real bankruptcy risks. Newfield Exploration (NFX) fits the bill here. They also advise looking at energy firms with strong enough balance sheets to survive if oil takes longer to rebound, but enough cash flow at $70-a-barrel oil to fund outsized production growth. Examples here include Anadarko Petroleum (APC) and Devon Energy (DVN) . In early trading Thursday, Brent crude prices jumped 2.5 percent to trade above $62 a barrel.
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Riley is a portfolio manager at Guinness Atkinson Global Energy (GAGEX) who may be worth listening to because his fund has a solid long-term record. It beats the market by 1.86 percentage points a year over the past 10 years, according to Morningstar.
Before we get to more names that meet the criteria above, why do these analysts predict oil will be higher in the second half of next year, when so many investors are so negative on crude?
Riley believes that even if OPEC holds the line, production cuts in North America combined with increased global energy demand sparked by declining prices will support a significant increase in oil prices by the second half of next year -- though moves over the next six months are anyone's guess. "The current price is unsupported," he says. There's also a chance that OPEC reverses course and cuts production.
Credit Suisse energy analyst Jan Stuart believes oil inventories will build in the first quarter of 2015 as U.S. producers will be slow to cut production. But he thinks the supply overhang will contract by the second half of the year -- driving WTI to $75 a barrel and Brent to $80 by the end of the year. "The unknown is how much pain is required for how long to elicit a material downgrade of activity in the U.S. shale," says Stuart.
How can you profit from this? Own energy stocks that have sufficient debt to be troubling enough to have fallen more than the "safer" names, says Riley, but not so much debt that they are at risk for bankruptcy. To illustrate this, Riley breaks energy names into four tiers.