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Why experts are saying you should brave the meltdown to buy ASX oil stocks

Broker holding red flag in front of bear

There’s a thin line separating bravery and foolishness. The ASX energy sector is shaping up to be the new testing ground for where that line is after the oil price crashed by around half this week.

The question is whether the meltdown represents the best buying opportunity in more than a decade or a devastating value trap.

The volatility won’t help either. The Brent crude benchmark bounced over 10% in overnight trade to US$37.90 a barrel but it’s still a far way from the recent peak of US$59.31 on February 20, which incidentally is when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index peaked as well.

Dead cat bounce

The coronavirus-induced correction was exacerbated by the oil price war that broke out between Saudi Arabia and Russia. The two major oil exporters continue to ramp up their battle to gain an upper hand, which makes last night’s oil price rebound feel like a dead cat bounce!

But experts think this may be a good time to be picking up battered and bruised ASX energy stocks. They’ve certainly become significantly cheaper in the last couple of days.

Better placed for a downturn

Morgan Stanley believes the risk-reward is more attractive during this oil collapse than it did in 2014 as ASX energy stocks are in a better position to manage weaker oil prices.

“During the last oil price correction (2014-2016), there were a number of equity raises across the Australian Energy industry as companies were mid-way through a heavy LNG construction cycle,” said the broker.

“This time around, balance sheets are better, operating costs are lower and spending really hasn’t started on expansion opportunities.

“There is time to delay these plans and ensure the commodity environment firms up.”

Morgan Stanley estimates that the market is pricing in a mid US$40 a barrel for the longer term, which is below what most commodity analysts are forecasting.

ASX energy stocks to buy

The analysts at Macquarie Group Ltd (ASX: MQG) are also feeling bullish about the sector even as they acknowledge the risk of widespread earnings downgrades from the weaker oil price.

The broker has an outperform rating on all ASX energy stocks under its coverage. This includes large caps like Woodside Petroleum Limited (ASX: WPL), Oil Search Limited (ASX: OSH) and Santos Ltd (ASX: STO). These stocks have the potential to generate a total return of anywhere between 60% to 90%.

Higher risk, higher reward

But if you want a bigger bang for your buck, you’ll need to look at the smaller end of the market.

The Karoon Energy Ltd (ASX: KAR) share price can potentially generate a 300% plus return, while Carnarvon Petroleum Limited (ASX: CVN) could return around 200% if they were to reach Macquarie’s price targets.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. 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 Scott Phillips.

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