Oil Stocks: Is a V-Shaped Recovery in the Works?

By Markets Fool.com

It's been a rough year for oil stocks. Persistently low oil prices continue to weigh on oil and gas activity, which is stunting the industry's growth. However, there are signs on the horizon that both oil prices and oil and gas activity is poised to pick up, leading one industry supplier to suggest that a V-shaped recovery could take shape by the first quarter of next year.

Continue Reading Below

Getting to the core of the matter
In Core Laboratories recent earnings release the company provided its outlook for the oil industry. The company noted that,

The balancing of worldwide crude-oil markets is well under way. U.S. production is starting to decline in the second quarter of 2015, and the most recent International Energy Agency estimates project worldwide demand to increase in 2015 by 1,100,000 barrels of oil per day ("BOPD") in response to low commodity prices.

As Core notes the oil market is turning around. Not only is supply starting to come down, but demand is starting to pick up as a result of lower oil prices. While both are important, it's the supply picture that's really the most compelling for investors because of what it means for oil stocks in the future. The company noted this by saying,

Core now believes that U.S. supply growth will roll over in May or June of 2015 and that year-over-year crude-oil production will be flat-to-down. As a lead example of the severity of production decline curves for unconventional oil reserves, Bakken production has already fallen by 50,000 BOPD during the first two months of 2015, or by over 4%. The Bakken requires approximately 115 new well completions per month to avoid production declines; and only 42 new Bakken well completions occurred in February of 2015, whereas new Bakken well completions averaged over 160 per month in 2014.

We see an example of what this does to oil production in the Bakken on the following chart by the U.S. Energy Information Administration.

Continue Reading Below

Source: EIA.

As that chart notes the production from new wells isn't enough to offset production declines from legacy wells leading to an overall decline in production in the region. This is decline is expected to continue as oil companies aren't completing enough wells to keep production steady, let alone from falling. Because of this Core Labs concludes that,

Therefore, at current activity levels, U.S. production could fall significantly in 2015 and 2016, while worldwide oil production continues to stagnate or decrease slightly because recent international production gains may not be sustainable over the long term.

The flying V?
This suggests that oil prices could be heading meaningfully higher. And, when that happens it will send oil and gas activity higher leading to a growth in earnings from oil stocks sending them higher, too.

Core Labs sees this turn being right around the corner as it said,

Core's view for the remainder of the year continues to be constructive, yet uncertain, while the Company's customers are prioritizing operating plans for conducting their activities in this environment. Consequently, Core is not able to provide quantitative guidance for the remainder of the year at this time, although from a qualitative perspective, the Company's sense is that industry activity levels will flatten in the third and fourth quarters of 2015, with a V-shaped recovery in activity levels starting in the first quarter of 2016.

As Core notes 2015 looks to be a lost year as drilling activity still hasn't quite bottomed. That said, it doesn't see too much downside in activity from here and instead sees flattening activity in the third and fourth quarters of 2015 before drilling activity really begins to take over in early 2016, yielding a V-shaped recovery in activity.

Investor takeaway
While it's just one company's opinion, the signs are all there that the oil market is bottoming and poised for a real recovery. There could be fits and starts along the way, but given how fast oil supplies are coming down there likely will be a meaningful rally in oil prices by the beginning of next year. That will incentivize oil companies to drill and could lead to a quick V-shaped recovery for oil stocks.

The article Oil Stocks: Is a V-Shaped Recovery in the Works? originally appeared on Fool.com.

Matt DiLallo owns shares of Core Laboratories. The Motley Fool recommends Core Laboratories. The Motley Fool owns shares of Core Laboratories. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.