With many contrarian investors now bullish on the outlook for oil companies, we run down the investment case and pick out a few stocks and funds to play the sector.

As the oil price continues its unlikely comeback, so too has the investment case for the commodity.

It’s billed by many as the ultimate contrarian call; a sector that is deeply unloved these days. But there may now be enough fund managers bullish on the prospects for oil and the companies involved in its production to dampen that claim somewhat.

We’re now past the worst of an extreme bear market for oil prices, brought on by a glut of crude oil. Brent crude fell from trading well above $100 in 2014 to bottom out late 2015 at less than $30. It’s since more than doubled to a shade below $70 at the time of writing, and has rallied 45 per cent since July.

“In the middle of 2016, universally the view was that the oil price was going down,” says Stuart Rhodes, manager of UK-based fund M&G Global, which holds a silver-medal rating from Morningstar UK.  “The view then was that electric vehicles are coming, the oil price is toast, it’s a dead industry, it’s finished--why would anyone invest in it?”

Rhodes disagrees: “It never was a dead sector. In 2015 and 2016 you got investment opportunities in a part of the equity market that you get once every generation.”

While the opportunity now is no longer to that extent, there are still plenty of attractive investments in the space. And there is a clear fundamental story around why things are rapidly improving in the sector.

The supply side has stagnated after years of under-investment due to the price crash production cuts from OPEC countries. Thomas Moore, who manages the UK-based Standard Life Equity Income Trust notes that new oil discoveries are at their lowest levels since the 1940s.

This has helped demand catch up to a point where, now, “we are pretty significantly undersupplied”, according to Rhodes. It took three or four years for demand to correct, he continues, and it’s going to take at least that long, if not longer, to return to an over-supply situation.

Further, the threat of electric vehicles to internal combustion engine cars is overblown--in the short term, at least. Around 60 million cars are produced worldwide each year, but fewer than one million electric vehicles are sold.

Electric vehicles will overtake internal combustion engine cars at some point, but Rhodes says it’s “almost mathematically impossible to assume a scenario where gasoline demand doesn’t go up every single year to the year 2025”.

So, where are the investment opportunities?

What about the oil majors?

The obvious starting point are the big guns, Royal Dutch Shell and BP. Both yield around 6 per cent and Shell has not cut its dividend since the second world war.

But many doubt the payouts of the oil majors. Ever since the crash, both BP and Shell have been either borrowing to fund their dividend, or paying the dividend by issuing extra shares, known as a scrip.

But they have also been busy cutting costs aggressively and repairing their balance sheets.

The firm’s yield premium is currently more than 50 per cent versus the FTSE All Share, as opposed to 26 per cent typically. This leads some commentators to suggest it has some re-rating potential.

Others believe that the role occupied by the likes of Shell and BP, as “integrated” majors. makes them less dependent on the oil price than some of their smaller peers. This is because their operations span the upstream (exploration and production), midstream (distribution) and downstream (refining) parts of the value chain.

Avoid the obvious stocks

Some fund managers explicitly avoid BP and Shell over concerns around dividends, instead, focusing on petrochemicals, energy infrastructure and oilfield service providers.

Within the two latter categories, US-listed oilfield services company Schlumberger and Canada's Pembina Pipeline are well-regarded international companies.

For investors focusing on locally-listed companies, oil and gas company Woodside Petroleum (ASX: WPL) saw a substantial increase in its fair value estimate in December, upgraded to $40 a share, from $35.50 a share.

"We think no-moat Woodside is 20 per cent undervalued, and rate it the best value of the three largest Australian names; the others are Santos and Oil Search," says Mark Taylor, Morningstar senior equity analyst covering the energy sector.

"We don't think the market sufficiently credits Woodside's ability to complete a capital-efficient second Pluto LNG train, nor its ability to increase North West Shelf Joint Venture life to greater than 20 years, and unfairly so. In our opinion, the stars increasingly point to development of new resources.

Though not without business risks--the scale of the major Browse Basin infrastructure development in Western Australia, for one--"our base case, however, assumes Browse will go ahead", Taylor says.

This upgrade comes in a rising oil price environment, with Brent crude hitting three-year highs of US$70 a barrel last week, with some industry commentators pointing to the risk of equating higher oil prices with rising oil company share prices.

While the rising price certainly helps, Morningstar's assessment runs much deeper than this, "argely accounted for "by our increasing the worth of other prospects excluding Browse gas, which is instead captured in assumed life extension and expansion".

"We think we previously understated the value in these assets, and that we were too bearish on future demand," Taylor says.

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David Brenchley is a reporter for Morningstar UK. Glenn Freeman is a senior editor for Morningstar Australia.

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