3 Stocks With Clayton Williams-Like Return Potential

By Tyler Crowe, Jason Hall, and Matthew DiLallo Markets Fool.com

There is a type of oil and gas investment for anyone's investing style. There are the slow and stable companies that have the assets and financial fortitude to work through the industry cycles. There are high-yield dividend investments for income seekers. Then there are the highly volatile exploration and production companies like Clayton Williams Energy that -- if timed just right -- can produce incredible gains over a short period of time. In the year leading up to Noble Energy's (NYSE: NBL) purchase of Clayton Williams for $3.25 billion, shares of Clayton Williams posted a 1,600% gain.

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It's safe to say that finding stocks like Clayton Williams and investing in them at just the right time is close to impossible, but we asked three of our contributors to do their best and highlight stocks they think have the potential to post some considerable gains in the coming year. Here's why they picked Chesapeake Energy (NYSE: CHK), Gastar Exploration (NYSEMKT: GST), and U.S. Silica Holdings (NYSE: SLCA).

Image source: Getty Images.

Rumors of Chesapeake's demise are greatly exaggerated

Jason Hall(Chesapeake Energy): In early 2016, Chesapeake Energy was on the ropesand bankruptcy had become a very real risk, as low energy prices, huge debt, and some unfriendly contracts with suppliers had management backed into a corner.

Fast-forward to today, the company has made a lot of progress. Debt is down and likely to fall even more. Costs per barrel of oil equivalent are down as the company improves its operations and moves forward under better, cheaper agreements with its suppliers and gathering/logistics partners. Furthermore, a major recovery in oil and gas prices over the past year is driving higher revenues and cash flows for Chesapeake, even as recent asset sales to pay down debt have cut production so far this year.

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Between the deleveraging of the balance sheet and improved commodity price environment, Chesapeake is now in a position to start growing its production again, even as it continues to sell off some assets to pay down debt. The company operated twice as many drilling rigs in the first quarter than it did to start 2016, and has increased the count further, with a goal of drilling 400-450 new wells this year. Management expects that this will support flat to mid-single digit production growth this year.

Put it all together and Chesapeake has indeed turned a corner. There are still risks ahead, but the company is far better prepared to deal with potential threats than it was in early 2016. All things considered, that makes Chesapeake a decent risk-reward opportunity for investors over the next few years.

Hoping for lightning to strike twice

Matt DiLallo(Gastar Exploration):Clayton William's rise from the ashes last year was an impressive feat. However, its rebound might not have happened if not for the lifeline provided by Ares Management (NYSE: ARES), which agreed to infuse $350 million in capital into the company lastMarch. That deal gave Clayton Williams some much-needed financial breathing room, enabling it to pay off debt and get back to drilling new wells. Those wells demonstrated that Clayton Williams was sitting on a valuable position in the Permian Basin, which eventually caught the eye of Noble Energy.The larger driller would go on to offer a stunning valuation considering that Clayton Williams almost went belly up. It's a deal that enriched investors, including Ares, which owned 35% of the company.

Ares has already found its next target to replicate that success in Gastar Exploration. The downtrodden driller struck a deal for a cash infusion from Ares earlier this year, receiving$425 million in financing via a term loan, convertible notes, and new equity. That capital enabled Gastar to redeem an upcoming debt maturity, pay down its credit facility, and provided it with money to drill new wells in the high-return STACK play of Oklahoma. It's a deal that already seems to be bearing fruit given the strong well results that Gastar reported during the first quarter. If future wells continue to outperform expectations, the company might eventually catch the eye of a suitor. If that happens, Ares and investors who join it could cash in on another big payday.

Find the pressure point

Tyler Crowe (U.S. Silica Holdings): Just about all the conditions necessary for the second wave of shale drilling in the U.S. have taken place: Oil prices have remained in relatively stable range, which is enough to produce a modest profit, and there are loads of idle service equipment and crews willing to work at a discount. With all of these conditions in place, there is one part of the shale drilling value chain that is emerging as the pressure point: frack sand supply. This could make frack sand suppliers -- an industry subsegment Wall Street left to die -- an incredible investment opportunity over the next year or two.

Producers have learned how to do more with less as of late. More efficient drilling operations and a better understanding of the underlying geology have translated into better well economics. What those producers have discovered, though, is that more sand per well improves economics -- basically, more sand holds open the rock fissures more and allows more oil to flow. As a result, total sand consumption today is higher even though total drilling rigs in the field are still half what they were prior to the crash. The diagram from fellow frack sand producer Hi-Crush Partners highlights how this dynamic has changed the game.

Image source: Hi-Crush Partners investor presentation.

Sand is in high demand today, and U.S. Silica looks to be best suited to generate returns from this dynamic. Not only are its financials in the best shape compared to its peers, but the company also is building out an extensive logistics network that does last-mile delivery. Getting sand that close to the wellhead should significantly boost per-ton margins and make the company a more profitable venture than the rest of the industry.

The big concern here is that sand supplies won't be able to keep pace with demand growth, and that is something U.S. Silica CEO Bryan Shinn noted on the most recent conference call. That could hamper production growth, but if U.S. Silica and its peers can grow production quickly, it looks like the price for sand will be there to support some considerable gains.

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Jason Hall owns shares of Chesapeake Energy. Matt DiLallo has no position in any stocks mentioned. Tyler Crowe has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.