High-Risk, High-Reward: Investors Turn Bullish On Small Cap Oil Companies

High-Risk, High-Reward: Investors Turn Bullish On Small Cap Oil Companies


Since the turn of the year, energy stocks have become a put owner’s dream—what with the energy sector virtually generating the worst returns of all US sectors.

And the harder you look, the worse it seems to get, making it nearly impossible to find any value in this gridlocked mess.

To say that small-cap oil and gas plays have been stinking the place out would be a severe understatement.

The sector’s favorite benchmark, the PowerShares S&P SmallCap Energy (NASDAQ:) has lost a shocking 57% of its value in the current year, a grim indication of just how dire the situation has become for small and producers.

This comes to nobody’s surprise, really, considering that small-cap oil and gas stocks tend to have higher leverage than their bigger brethren. This makes them high-risk investments only fit for investors who can withstand their stomach-churning volatility.

Yet, at the same time, the massive selloff provides good opportunities for dumpster diving value investors.

On the one hand, companies like Shell (NYSE:) and BP (NYSE:) have issued a really gloomy long-term outlook with BP recently coming out and saying that oil demand might never fully recover if the world’s governments begin to get aggressive with their climate change goals. On the opposite end of the spectrum are contrarian investors who remain skeptical about the terminal decline thesis and are optimistic that yet another government bailout package could set the sector on a recovery path.

XLE Regular Dividend Chart

If you belong to the latter camp, here are three beaten down small-cap oil and gas stocks worth a second look.

1. Oasis Petroleum

  • Market Cap: $158.3M
  • YTD Change: -87.4%

Oasis Petroleum Inc. (NASDAQ:) is an oil and gas shale producer operating from the North Dakota and Montana regions of the Williston Basin and the Texas region of the Delaware Basin. As of the end of 2019, Oasis held approximately 286.4 million barrels of oil equivalent of estimated net proved reserves. But investors hardly seem to care about Oasis’ apparently undervalued resources, instead choosing to focus on its debt conundrum. With a long-term debt of $2.7B and negative shareholder equity, investors have been bailing on this company leading to the stock crashing 97% from its September 2018 peak. It’s been from the frying pan to the fire for Oasis after it recently defaulted on its debt repayments leading to yet another selloff. Bloomberg has reported that Oasis owed interest on $244.8M of convertible notes and $834.5M of unsecured notes maturing in 2022.

Interestingly, Oasis’ management is adamant that the company has “sufficient liquidity” and says it has entered a 30-day grace period that will allow it to defer interest payments that are due Sept. 15. Who knows, maybe Oasis will borrow a leaf from Whiting Petroleum (NYSE:) whose stock surged more than 4,000% in the space of just 48 hours after it emerged from bankruptcy just four months after filing for Chapter 11. Just be sure to get your timing right and avoid holding the shares prior to any bankruptcy event, or you run the risk of receiving a single share for every 75 shares you hold a la Whiting.

Another caveat: OAS has a high short interest of 25%, which could create an opportunity for a nice short squeeze but also means the odds are definitely stacked against this stock.

2. Northern Oil and Gas

  • Market Cap: $257.4M
  • YTD Change: -75.4%

Northern Oil and Gas Inc. (NYSE:) has a rather unique modus operandi in that it invests in oil-producing properties, acting as a financial partner to exploration and production names. The company has more than 6,000 gross producing wells, primarily in the Bakken. It’s intriguing to know that NOG stock has actually climbed 123% since its March lows yet remains a whopping 75% below its valuation at the beginning of the year. The latest move came in early September after NOG jumped more than 15% after it announced that it had agreed to acquire its first non-operating interest in the Delaware Basin in a $12M deal. That piece of news would have hardly turned heads if the buyer was an Exxon (NYSE:) or a Chevron (NYSE:). The fact that a financially distressed company with $924.17 million in long-term debt and $72.89 million in current debt (debt-to-equity ratio of 2.7x) made such a bold move still deep in the throes of the crisis means that NOG really does believe that an oil price rebound remains firmly in the cards, in which case its latest purchase could end up being a massive bargain. Further, NOG upped its Q3 production guidance by roughly 10%.

Last, but by no means least, NOG remains hedged on the majority of its oil production through 2021 at attractive oil prices. Specifically, the company has hedged an average of 24,787 barrels of oil per day for Q4 2020 at approximately $58 per barrel and another 21,393 barrels per day in 2021 at approximately $55 per barrel.

All these are bullish catalysts for the company.

3. Torchlight Energy Resources

  • Market Cap: $30.4M
  • YTD Change: -66.6%

Torchlight Energy (NASDAQ:) engages in the acquisition, exploration, exploitation, and/or development of oil and natural gas properties in the United States.

This Texas Wildcatter purchased a neglected oil patch in the Orogrande Basin on the cheap back in 2015. The Orogrande Basin is actually considered a pariah among E&P circles, and Torchlight set out to prove the naysayers wrong. The company plans to walk off the beaten track by employing Frac tech and believes the patch could yield as much as a billion barrels of oil–which would be a record for a small-cap.

This speculative play has definitely been worth watching.

In February, Torchlight announced that it had measured “substantial” initial potential oil and gas hydrocarbon recoveries from its recently drilled and completed Cactus (NYSE:) A35 #1H test well in west Texas’ Orogrande Basin. The news sent the shares soaring 15% in intraday trading.

Unfortunately, concerns of high cash burn and growing leverage have been weighing heavily on the stock–and Torchlight’s time could be running out.

Back in July, Torchlight was able to sell shares worth $3M in the capital markets, which it intends to use to pay down debt, in drilling obligations and general corporate purposes. However, even that door might soon close: In August, the company received an extension to meet its minimum bid requirement with NASDAQ for 180 days or until Feb 1, 2021 or risk being delisted.

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