There has been only one bright spot in what’s turning out to be an annus horribilis for U.S. stocks – the energy sector.

The S&P 500 has fallen into a bear market, down more than 20% this year. The benchmark index is on pace for one its worst opening six months since 1970. Historically, there have been only five times since 1932 that the S&P 500 lost 15% or more in the first six months of a year.

In contrast, energy stocks have climbed more than 30%, even after the sharp drawdown over the past two weeks amid a broad market sell-off and a fall in the price of crude oil.

However, I still think that the energy sector has much further to run as we enter – or have already entered – a structural bull market for commodities.

For certain, a structural deficit in the oil market has emerged since the pandemic and the Russian invasion of Ukraine.

That is just part of the story, though.

Other factors, not the least of which was a lack of investment in upstream exploration over the past few years, has left global capacity in a tough spot. As President Macron of France told President Biden recently, even Saudi Arabia has only about 150,000 barrels of spare capacity that can be brought online within six months.

Meanwhile, oil demand is set to top pre-pandemic levels next year, with 80% of the growth in demand coming from non-OECD nations. Just as the West seeks to use less oil, its demand is being replaced quickly by the emerging markets.

All of this is very good news for any oil company that can increase its oil output at low cost to take advantage of high prices.

One such company is Hess Corporation (HES), which is highly leveraged to the price of oil. Let’s take a look…

Hess and the Stabroek Block

This company is not one of Wall Street’s favorites because of its high debt level. At the end of the first quarter, its debt to capitalization ratio was above 55%. But with so much revenue coming in, that is much less of a concern.

Currently, Hess is one of the largest producers in the Bakken Shale. This includes a large portion in the

highly productive area near the Mountrail-McKenzie county line in North Dakota. Management believes this acreage still contains at least 2,000 incremental drilling opportunities and hopes to develop this asset with a four-rig program in the long run (giving it well over 10 years of potential drilling inventory). Four rigs would optimize the usage of its infrastructure and keep production flat at around 200 million barrels of oil equivalent per day.

However, the real excitement for investors in Hess is centered on the growing Stabroek Block, offshore Guyana. Morningstar called it “the firm’s core growth engine going forward and is a game-changer for the company, due to its large scale and exceptional economics.” 

This area is one of the highest margin, lowest carbon intensity oil developments globally, according to a report by the energy consultancy Wood Mackenzie. Barrels from this field, the largest discovered in the last decade, are mainly light, which helps meet the rising demand for relatively low-carbon-intensity liquids.

The Stabroek Block, where Hess has a 30% interest and ExxonMobil (XOM) is the operator, is large and continues to grow. The company recently increased the gross discovered recoverable estimate to

approximately 11 billion barrels of oil equivalent, up from the previous estimate of about 10 billion.

Current management guidance indicates 6 development phases will come online by 2027, resulting in gross volumes of about 1.2 million barrels a day of oil output. But with over 20 confirmed discoveries already, this may be too conservative (management has hinted at possibly 10 phases of development).

Hess currently operates the Liza field, where its Phase 1 project is expected to increase to more than 140,000 barrels of oil per day within weeks. And the Liza Phase 2 development is ramping up quickly to approximately 220,000 barrels of oil per day by the third quarter.

In April, the company announced it is going ahead with its fourth development in the field, Yellowtail, which should produce 250,000 barrels per day starting in 2025. The third development on the Stabroek Block at the Payara Field, with capacity of approximately 220,000 barrels of oil per day, is ahead of schedule and expected to start producing in late 2023.

Goldman Sachs analysts sifted through hundreds of oil and gas projects globally and identified Hess as one the few “winners” who “own material new projects that are highly profitable and will materially lift their future cash flows and production”.

The analysis is spot on. The company’s four oil developments in Guyana have a breakeven oil price of between $25 per barrel and $35 per barrel. And, by 2026, the overall company breakeven oil price is forecast to decrease to an oil price of roughly $45 per barrel.

This will translate to cash flow growth being strong over the coming years. Cash flow is forecast to grow at 25% annually through 2026, more than double the top-line growth.

That makes Hess stock a buy on its recent weakness it is down to around $110 a share from its recent high at $131.44. Anywhere from $110 to $118 is a reasonable entry point.