This turnaround stock could win big for energy investors

Stocks listed on the ASX that extract or mine coal, oil, gas, gold, iron ore, bauxite and rare earth elements (along with many others) can all share the umbrella term “commodity stocks”. But while they might share a classification, these commodity stocks conduct vastly different operations and operate vastly different businesses.

And the macroeconomic factors affecting each commodity are also different. For example, coal is plentiful across the world, and relatively easy to extract, so the market has been in oversupply for years. High quality iron ore is less common, with Australia and Brazil having the highest grades. However, iron ore futures are heavily dependent on one country, China, which has been buying less of late.

The good oil

However, oil, is a little more interesting. Unlike coal and iron ore (and other “hard” commodities) oil can’t simply be stacked up in enormous piles when you have too much of it. It has to go in a tank, reservoir, or as a last resort, on an oil tanker.

But with even the last resort tankers moored off the coast of the United States and the Gulf Coast at capacity the signs are that marginal producers might have to stop pumping soon, as there is too much oil and nowhere to put it. And if marginal producers stop pumping, they go out of business, as many are saddled with debt raised at high interest rates. As the marginal producers go broke, supply and demand rebalances, and the oil price recovers.

So which ASX stock is superbly placed to take advantage if this thesis plays out?

Woodside Petroleum Limited (ASX: WPL) is perhaps the strongest exposure on the ASX to a rising oil price. Although the company is a natural gas producer, the gas price is pegged to the price of crude oil through a complex formula. The relationship is simple though: higher oil prices equal a higher natural gas price.

Woodside has been in business extracting gas off the coast of Western Australia for almost three decades, and more recently it commissioned the giant Pluto project in 2012. The Pluto Project, along with the older North West Shelf project are enormous, long life, high quality natural gas reserves.

This is crucial as it means that even in times of low prices, Woodside is a higher margin producer than its peers. Another crucial factor in favour of the company is the fact that the majority of its gas is taken under long-term supply contracts with overseas utility companies or large manufacturers, who will always need a stable, reliable source of energy.

Also, unlike iron ore, natural gas does not have a well-developed “spot pricing” market, which means that producers are not held hostage to daily prices in the way that iron ore miners are.

Woodside recently reported underlying profits of $1.1 billion US dollars, which beat expectations.

In addition, due to the relatively low level of debt on its balance sheet and distressed state of other players in the market with high debt burdens or weak balance sheets, Woodside could be an acquirer and consolidator of energy assets during this downturn. Simple logic dictates that the time to buy assets is when they are “on sale” and not when they are hugely overvalued.

Foolish takeaway

There is no real way to predict when the oil supply and demand imbalance will correct. But simple economics dictates that it will correct at some point, which will mean increased oil and natural gas prices. When that happens, Woodside could be one of the best stocks on the ASX to own a piece of.

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Motley Fool contributor Ry Padarath has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. 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. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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