Oil stocks that could rally

Give credit where credit is due. OPEC and some non OPEC producers have done a great job in talking up the oil market from its recent low near $26 per barrel. The production freeze has not taken a single barrel of crude oil off the market yet prices have risen over $10 in the last two weeks. That of course begs the question, what is the market looking at and what is the opportunity for investors?

Workers on a drill site at the Permian basin outside of Midland, Texas
Brittany Sowacke | Bloomberg | Getty Images
Workers on a drill site at the Permian basin outside of Midland, Texas

The talk of a production freeze shows just how much financial stress oil producing countries are under. Even Saudi Arabia is feeling the pain, raising domestic gasoline, diesel, water and electricity prices and selling bonds to finance some spending. The traditional OPEC price hawks like Venezuela, Ecuador and Nigeria will not cut production, Iraq and Russia boast record production levels and Iran plans to produce at pre sanction levels as soon as they can.

But a production freeze is being interpreted by the market as a precursor to a production cut. By mid to late summer, we will have a good idea of how much oil Iran has put back on the market. Actual OPEC production levels will probably be 700,000 barrels per day higher than they are today, but OPEC will know where they stand.

At the same time, they will have another six months of data regarding shale production in the USA. They will know where we stand. Then OPEC will be able to announce a production cut, from some very high level, save face, and hopefully see prices rise and declare victory over a bearish crude market.

While the near term looks awful regarding supply and demand, things do look better by the middle of 2017. World oil demand continues to grow, high cost investment areas will not see any new money, and to get more oil out of the ground prices need to rise to $50. And that next tranche of crude oil will come not from Canada, not from the Arctic, not from deep water Africa, but from the shale oil producers and their service providers.

If one is willing to take a long term view, the shale oil producers I like are Pioneer Natural Resources, EOG Resources, and Devon. One should also have a look at Hess Corp and perhaps Whiting Petroleum. If fracking survives, then some better times are ahead for those companies providing the sand to the frackers. That would benefit Hi-Crush Partners and Emerge Energy. I would also expect Halliburton and Schlumberger to rally.

For those more interested in trading the oil futures market, it's still oversupplied, and Cushing storage facility is at record inventories. Rather than trying to decide whether the price is going up or down, I like playing the spread trade between months expecting the contango to deepen. Unfortunately for refiners, product inventories are seasonably so high that it is difficult to say that they are a buy. However, if you see gasoline inventories drop 10 million barrels over the next month, the gasoline crack will rally and so will Valero, Tesoro, Marathon and Phillips66.

OPEC's words have spoken louder than any actions that they have taken, but the market reaction has been rather swift, up over 45 percent from its low. This summer might see OPEC take action speaking louder than their words.

Commentary by Andy Lipow, president of Lipow Oil Associates.

Disclosure: Andy Lipow and Lipow Oil Associates do not own or trade any of the stocks mentioned above.