This week, the Trump administration announced it was officially pulling the U.S. out of the Iran nuclear deal. The deal was originally signed by Iran, along with the multilateral agreement of the P5+1 group of world powers – the U.S., U.K., France, China, Russia and Germany – in 2015, but has long been panned by President Trump as a bad deal for the United States. The move is being roundly criticized by the European countries that signed the original accord and have, along with Iran, publicly stated they intend to continue to abide by the terms of the deal, and Russia and China are expected to follow suit. It’s a move that is being seen to isolate the U.S. even further by critics, while supporters point to the Trump administration’s recent success in getting three American hostages released from North Korea as proof that maximum pressure tactics can force a recalcitrant adversary to the bargaining table.
Some analysts have predicted that the pullout of the deal, and the reimposition of sanctions against Iran that were lifted in 2015 could force oil prices higher. So far, the effect has been mostly muted, probably because this is a move that has been telegraphed for months, which gave the financial markets an opportunity to price in the expectation of the pullout ahead of time. As of this writing, both Brent crude oil (the benchmark for oil exports from the Middle East) and West Texas Intermediate crude are up about 3.3% from their Tuesday closing levels. Most of that move came yesterday, and while that’s sizable for a single day’s activity, there are a few questions that have yet to be answered about what kind of impact restrictions on Iranian oil will have on the global market, or on prices in the U.S.
Worldwide, approximately 98 million barrels of oil are produced daily, and Iran represents about 4% of that amount, with a contribution of roughly 3.8 million barrels. Sanctions on Iranian imports by the U.S. could reduce that number by 10 to 15 percent, putting their daily production at around 3.23 million barrels daily. The caveat is that it would probably take about six months or even longer for that drop to actually be felt. That drop could also be offset in other areas of world that are highly dependent on Iranian imports and are unlikely to follow America’s lead. China and India, for example, currently purchase approximately 40% of Iran’s exports, and could probably increase their consumption by 150,000 barrels or more apiece.
Domestically, the U.S. doesn’t import any oil from Iran, which means that the impact felt by U.S. consumers will be incidental to renewed sanctions on the global impact on prices. Any reduction, short or long-term in production from Iran could boost the price of Brent oil above its current levels, but it begs the question of America’s ability to rely on its own oil production. The largest portion of U.S. oil production comes from the great state of Texas, with two fields, Eagle Ford, and the Permian Basin providing the largest existing reserves. The Permian Basin in particular has provided the biggest boost in recent years to U.S. production, a shale field that has unique geological characteristics that makes drilling and extraction much easier and cheaper than other areas. That affordability made the Permian basin the only major shale basin where production managed to grow when oil prices dropped to as low as $26 per barrel in 2016.
The flip side of the Permian Basin’s increase in production is that the pipelines that transport oil from the region haven’t been able to keep up with the output. That lack of capacity has played its own role in the fact that West Texas crude prices have surged more than 18% since the beginning of 2018, but it also opens the door of opportunity for investors to focus on the companies involved in pipeline construction and oil transportation from the area. Much of the infrastructure needed to support increased production from the Permian Basin will begin to come online late next year. Here are three stocks that you should pay attention to.
Phillips 66 (PSX)
Current Price: $117.96
PSX is a well-known, $55 billion company that is a primary partner in Gray Oak Pipeline LLC, a pipeline that was given an official green light to begin construction last month. This pipeline will transport oil from four counties in West Texas to terminals in Corpus Christi and south of Houston. It is initially expected to transport about 700,000 barrels per day (bpd), with capacity to eventually expand to as much as 1 million bpd. It is scheduled to come online late in 2019.
From an investor standpoint, PSX has already enjoyed a long bullish run, rising from a low at around $76 in June of 2017 to its current price, which marks a new all-time high. That could call into question how much opportunity remains in a stock that has already increased in value by 55% over the last year. An effective counter to that argument can be made by looking at the company’s PEG ratio, which measures the company’s current price-to-earnings against its forecasted growth rates. The PEG ratio for PSX is 1.97, versus an industry average of 3.77. On that basis, PSX is undervalued by more than 50%, putting a long-term target price for the stock above $200 per share.
Plains All American Pipeline, L.P. (PAA)
Current Price: $24.09
Like PSX, PAA is building its own pipeline running from the Permian Basin to Corpus Christi, called the Cactus II. The pipeline is expected to be online in the third quarter of 2019 and will cost an estimated $1.1 billion. The pipeline will boast capacity of almost 600,000 bpd and is already 90% committed with long-term contracts.
PAA doesn’t carry the same brand-name recognition that PSX boasts, and it carries a lower market cap at $17.5 billion, but for value-oriented investors the opportunity is probably easier to justify. The stock is more than 25% below its 52-week highs, which were reached at the beginning of year. Since late February, the stock has rallied from a short-term downward trend low at around $17 to its current price, showing considerable bullish momentum. PAA has an excellent fundamental profile, with excellent cash flow and good debt management. The value opportunity is also excellent, with the stock trading at a significant discount based on the stock’s current price-to-cash-flow levels, which are more than 30% their historical averages.
Buckeye Partners, L.P. (BPL)
Current Price: $41.76
Of the three companies in this list, BPL is the smallest, with a market cap of about $6 billion. Their most recent news, at first blush might also seem mostly negative, since announced it had cancelled its open season to gauge market interest for its own pipeline project, called the South Texas Gateway pipeline. While lack of interest doesn’t seem to have been a concern, the company has instead chosen to focus on a joint venture project with PSX and Andeavor (ANDV) that will act as the primary terminal outlet for the Gray Oak Pipeline project. BPL will own 50 percent of the terminal, which is similarly named the South Texas Gateway Terminal. The other 50 percent is split between PSX and ANDV; BPL’s majority ownership gives it a major stake in the crude and petroleum exports market, since the terminal will have capacity to store 3.4 million barrels of oil with two-deep water docks to facilitate sea transport.
BPL’s price has followed an extended downward trend, retreating from a high point at about $73 per share to a recent trend low at around $37 per share. That’s a 50% drawdown since February 2017. The fundamental profile is solid, with healthy debt management and solid cash flows. The value proposition is the easiest to justify, since the stock is currently trading 50% below its historical Price/Book ratio. That puts the stock’s long-term target price above $80 per share.