The top E&P and natural gas stocks to own in 2024, according to JPMorgan

While JPMorgan acknowledges that energy Exploration & Production, or E&P, stocks lagged the broader market in 2023, it believes prospects look better for 2024. The firm also sees a tale of two halves in U.S. natural gas. As such, and given the mixed macro backdrop, JPMorgan believes companies such as EQT Corp. (EQT), Diamondback Energy (FANG), Marathon Oil (MRO), Ovintiv (OVV), and Permian Resources (PR) stand out. The firm – which has updated its “forced ranking” system on key valuation, cash flow, cash return, and balance sheet metrics – noted that its top picks in the space are Coterra Energy (CTRA), Marathon Oil, Ovintiv, and Permian Resources.

STOCK SELECTION “PARAMOUNT”: A year ago, JPMorgan argued that the outlook for the E&P sector was “glass half empty” given rising capital intensity from higher oilfield services costs, declining well productivity, and a step down in cash return, but now the firm sees better risk-reward for the group in 2024. The improved “micro” prospects for the group stem from significant D&C efficiency gains and deflationary tailwinds, which are more than offsetting modest declines in well productivity and should lead to better overall capital efficiency in 2024.

The macro picture is admittedly more mixed, dimming some of the firm’s “micro” optimism. While the post pandemic recovery in oil demand has largely played out as expected, the continued intervention from OPEC+ to subsidize the global market suggests more limited upside risk to oil prices over the next 12-months, although it would seemingly protect a floor above $70 per barrel Brent, it says.

JPMorgan sees a tale of two halves in U.S. natural gas, with a supply led imbalance in the first half of 2024 giving way to more constructive balances approaching 2025. The firm believes it is a bit too premature to make the bullish 2025 natural gas call, particularly given the unexpected 2.6 Bcf/d MoM increase in U.S. natural gas production in November. Given this mixed macro backdrop, it thinks stock selection will be paramount and while well productivity remains important, the firm believes the ability to harness efficiency gains by compressing cycle times is a critical factor for success, particularly given the shift to maintenance capex programs across the industry. In its coverage group, companies such as EQT Corp., Diamondback Energy, Marathon Oil, Ovintiv, and Permian Resources stand out.

RATING SHAKEUP: JPMorgan has also updated its “forced ranking” system on key valuation, cash flow, cash return, and balance sheet metrics. The firm upgraded Ovintiv to Overweight from Neutral, Devon Energy (DVN) to Overweight from Neutral, and Southwestern Energy (SWN) to Neutral from Underweight, and downgraded EOG Resources (EOG) to Neutral from Overweight and Range Resources (RRC) to Underweight from Neutral on valuation. Its top picks are Coterra Energy, Marathon Oil, Ovintiv, and Permian Resources.

M&A SET TO CONTINUE: The largest deals in 2023 year-to-date were public-to-public transactions, including Exxon Mobil’s (XOM) $65 B acquisition of Pioneer Natural Resources (PXD) and Chevron’s (CVX) $60 B acquisition of Hess Corp. (HES). Going forward, the firm expects a robust level of M&A to continue given the focus on scale and inventory depth. Recent conversations with companies have indicated a scarcity of remaining Permian-focused privates that have significant inventory depth remaining, which JPMorgan thinks could spur additional public-to-public M&A transactions.

With large cap E&Ps trading at a about 1.3-times multiple premium to Smid caps, the firm believes there could be a continuation of public-to-public M&A deals due to the valuation discount of Smid caps vs. large caps, with potential consolidation candidates including Permian Resources, SM Energy (SM), Callon Petroleum (CPE), and Southwestern Energy.

PRICE ACTION: In Wednesday afternoon trading, shares of EQT have dropped almost 3%, while Coterra, Diamondback Energy, Ovintiv, and Marathon Oil have slipped about 2%. Also lower, Permian Resources’ stock has dropped a little over 1%.