Investors pick drilling winners as oil nears $35

Oil below $50 'a challenge' for most producers: Pro

OPEC's decision last week to maintain oil output at existing levels sent crude prices to nearly seven-year lows on Tuesday, raising the stakes for already hard-hit U.S. drillers.

But even with oil at new lows, a number of exploration and production companies saw their shares rise on Tuesday. Analysts said few oil drillers of significant size are expected to collapse in the face of current prices, but the day's buying offers clues about who the market believes will come out on top.

On Tuesday, U.S. crude settled at $37.51, its lowest close since Feb. 18, 2009. It fell as low as $36.64 during the session.

US drillers stuck with negative cash flow and lots of debt
How cheap oil raises political risks in Saudi Arabia
An oil pump jack in Gonzales, Texas.
Energy infrastructure MLPs to bounce in 2016: Trader

Debt levels look problematic for a number of companies if futures prices meet expectations next year, according to research by investment bank Tudor, Pickering, Holt & Co.

Assuming the monthly U.S. crude contract averages $46.25 next year, the firm sees some oil producers' debt reaching roughly four to five times earnings before certain expenses. Those names include Continental Resources, Cabot Oil & Gas and Jones Energy.

But even some of the names with high debt-to-earnings ratios rose on Tuesday.

Investors may now be positioning themselves for a long-term stabilization in oil markets as crude prices become too low to make it worthwhile for U.S. producers to bring new production online, Cowen and Co. senior analyst Sam Margolin said Tuesday.

"At these prices, you're just not going to have any reinvestment in the business, and it's inevitable that production declines," Margolin told CNBC's "Squawk on the Street."

Asked whether current prices portend a fall in production, Margolin noted few U.S. oilfields are economic below $40 per barrel, and conditions are challenging even at $50 a barrel.

Iberia Capital Partners managing director Eli Kantor said most buyers were focused Tuesday on the shares of companies positioned to weather the storm.

"Most of the market action you're seeing today is a continuation of what we've seen over the last 19 months, where investors are favoring better balance sheets and higher asset quality," he told CNBC.

Among those exploration and production companies are Diamondback, Energen, Concho Resources, EOG Resources and RSP Permian, he said.

Many investors now favor players in the Permian Basin in West Texas and New Mexico, where drillers are extracting oil at prices below other fields' production costs, Kantor said. The geology of the basin also gives drillers more opportunities over a longer period of time to capitalize on the assets than in other areas, he said.

Tortoise Capital Advisors portfolio manager Rob Thummel said Monday that he does not expect to see near-term U.S. crude production growth anywhere except in the Permian Basin. He noted the area's Midland Basin is one of the few places where drillers have added oil rigs.

"The focus for the oil stocks right now are really predominantly the Permian Basin and the Eagle Ford Shale because that's where you can make money even in this lower oil price environment," he told CNBC's "Fast Money: Halftime Report."

That's also why asset purchases have continued in the Permian, and to a lesser degree in East Texas' Eagle Ford, even as merger and acquisition activity in the oil patch remains mostly frozen.

The Permian had the highest number of deals worth $50 million or more in the third quarter. The play saw seven deals worth $4.1 billion in the third quarter, followed by the Eagle Ford with five deals worth $2.8 billion, according to PricewaterhouseCoopers.

As potential buyers consider the cost of bringing oil to market, the Permian's well-developed infrastructure and the Eagle Ford's proximity to the Gulf of Mexico are significant considerations, said Doug Meier, PwC's oil and gas deals leader.

Meanwhile, North Dakota's Bakken Shale looks less attractive because of its remote location and reliance on costly rail transport.

"You look at [the Permian] and buyers say, 'Hey this is an attractive play.' It's been proven, so there is less uncertainty around the get-to-market attributes of the play versus the Bakken," Meier said.