Three Stocks to Buy During the Oil Contango

This time six years ago, the oil market had similar problems.

Demand was low, and producers had an oversupply of crude oil, causing prices to collapse even further than they have during the current bear market.

In January 2015, we entered into the exact same market phase as we did back in 2009.

The phase is called a contango, and it changes how oil companies drill and sell oil in order to boost profits.

A contango is when the current cash price of oil is lower than the projected price for a date in the future. Right now, despite oil’s jump in early February, prices are in a contango.

This means prices are surely going up in the future, so companies will do everything in their power to wait to sell oil in order to get the most profit possible.

A lot of companies will store oil instead of selling it. During the contango in 2009, oil companies were storing over 50 million barrels of oil while waiting for prices to rebound.

And as the chart above shows, rebound they did.

So what can we do about it now?

Well, because of the shale revolution, there’s an innovative new way for shale companies to store oil without creating too many cost issues.

In-Ground Storage

The problem oil companies have during a contango is that it’s difficult to predict when the market will move up enough to make oil storage worth the time and money.

Think about it: If companies have to pay to store the oil in tankers offshore, then the cost per barrel will go up. If oil prices don’t match, companies could lose money.

The sure thing for investors in a contango is usually tanker stocks or onshore storage companies. These stocks are still going to fare well (I’ll recommend some in a moment). But there is a new way companies are taking advantage of the oil contango…

EOG Resources, a significant shale oil producer, recently announced that it plans to store its oil underground.

See, when fracking an oil well, there are two distinct phases of production. The first is drilling, and the second is called completion.

When the company drills the well, it simply creates the proper channels through which oil can flow — it doesn’t actually extract any oil. The completion phase is where companies pump water, sand, and chemicals at high pressure into the shale rocks in order to harvest the oil they sell.

In most cases, the completion phase is near two thirds of the cost per barrel.

What EOG and many other companies are doing now is only finishing the first phase of production. By drilling the well without completing it, they are leaving oil stored underground until prices allow fracturing to be more profitable.

At the end of 2014, EOG had 200 wells ready for completion, and the company plans to have 285 ready by the end of 2015. This means that whenever oil prices go up significantly, the company will pump a windfall amount of crude and stay profitable.

This is a great innovation for the oil market, especially during the contango phase, which is why we’re suggesting investment.

Three Worthwhile Contango Stocks

There are three stocks positioned to do well either during the contango phase or just after it ends.

The first should be a no-brainer: EOG Resources, Inc. (NYSE: EOG).

As I stated above, EOG is using innovative methods to boost profits, and although the stock isn’t cheap at $90 per share, the company does pay a dividend and has tremendous reserves totaling over 2 billion barrels worldwide.

With its drilling plan geared toward the most profit possible, the company stands to benefit investors more than other drilling stocks once oil does rebound.

Like I promised earlier, offshore and onshore storage companies will still benefit during contango…

So the next stock is an offshore tanker company called Teekay Tankers Ltd. (NYSE: TNK).

The company saw its revenue jump to $75.9 million last quarter and earnings of $20.3 million, beating all analyst expectations and crushing the $42 million it had in revenue for the same quarter in 2013.

A lot of this extra money can be attributed to the contango phase, causing oil producers to pay Teekay to store its oil offshore. We expect the first quarter numbers for 2015 to be even better.

The company also pays a 2.2% dividend that will hold us over while we wait for the shares to go up as the contango deepens.

And finally, that brings us to the third stock, an onshore storage company with a lot of upside…

Tesoro Corporation (NYSE: TSO)

Like EOG, Tesoro is another company whose shares are a bit pricey but should be worthwhile during a contango.

The company has multiple storage and refinery operations in five states in the U.S. including California, North Dakota, and Utah — three states in which it is the only company with similar operations.

Tesoro has over 20 refined product terminals in the Western U.S. and has the ability to store, market, and refine crude oil for sale, which is incredibly valuable during the contango. Here’s the chart…

The company pays a 1.5% dividend and is fairing well during the recent refinery worker strike, which has taken a toll on operations. But according to news out this morning, the Steelworkers Union and refiners are ready to negotiate.

We’ll wait for the end of the negotiations to see how it affects the stock, but the company is worth watching over the next few months despite its large price tag. And because of the contango, Tesoro stands to make a lot of money.

Still, if you’re worried about the expense, I suggest you check out this stock recently recommended by my colleague Keith Kohl. It’s cheaper but will see large gains during oil’s rebound.

Good Investing, 

Alex Martinelli

With an eye squarely focused on the long-term, Alex Martinelli takes the art of income investing to a higher level within the energy sector. His research has helped hundreds of thousands of individual investors identify well established companies that have a long history of paying out dividends to their shareholders. For more info on Alex, check out his editor’s page.