Think Oil Is Going Up? Then You Need to Own Penn West Petroleum Ltd.

Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE) could soar if oil recovers to a more normal level. Here’s why.

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2015 has been quite the year so far for Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE).

For most of January, the stock was a dog. As oil fell below $50/barrel and then briefly below $45, doubts of Penn West’s future as a viable company began to rumble through the market. Word leaked that the company had already begun negotiations with its lenders regarding the covenants on its debt. Although you could argue that being proactive with lenders is a prudent move, the market was obviously spooked at the news that management was admitting that a technical default was possible. Even though it’s likely that breaking a debt covenant won’t lead to Penn West’s bankruptcy, it’s still a concerning piece of news.

After shares flirted with $1.75 each on January 29, the price of oil finally began to recover. The commodity rallied nearly 10% in one day and has held up over $50 since. Although it’s only been a week, investors are beginning to think the bottom in oil may be past us. Value investors have been swooping into the sector and buying some of the more beaten-up names.

Penn West might be the biggest beneficiary of that. Since bottoming, shares are up more than 50% in just five trading days. That’s a huge move, but if oil cooperates, it could just be the beginning.

A levered bet on oil

Essentially, Penn West can be boiled down to one simple concept: it’s like betting on oil, but on steroids.

Thanks to all the hard work instituted by management before oil fell, Penn West has become more competitive. It cut costs and sold non-core assets. It’s newly focused on just a few areas where it can achieve good results. The company’s results were improving and the balance sheet was becoming less levered with each passing quarter. A lot of the heavy lifting has already been done; the price of oil has just delayed the comeback.

But Penn West isn’t out of the woods yet. I’ve crunched the numbers, and it looks to me that the company needs oil to be at $65 per barrel for it to be a viable producer. The decline in the Canadian dollar is helping — remember, expenses are in Canadian dollars, while WTI is priced in greenbacks — but the company still needs some commodity help before it can rise from its deathbed.

Personally, I think that help is coming. Rig counts across North America are shrinking, and reduced capital spending across the board will ensure the sector doesn’t come roaring back. Bankers who are looking at a bunch of now-risky energy loans will think twice before lending so much — at least in the short term.

Besides, most oil companies need at least $75 per barrel to be profitable producers. Even at $60 or $65 per barrel, oil production isn’t going to come back in a hurry. It might slowly come back, but I doubt there will be many energy companies itching to spend after the pain they’ve just experienced.

What does this mean for Penn West?

For Penn West, this is a very bullish scenario. Say oil trades up to my mid-term price target of $70 by the end of 2015. Considering how much the company’s shares have gone up when oil went from $45 to $50, I think shares could easily double once again if oil can reach $70 per barrel. Penn West would rid itself of bankruptcy concerns and generate enough cash flow to continue expanding.

Although I don’t know for sure what Penn West’s price will be if oil does recover, it’s obvious that the stock has become a way to make a very aggressive bet on the price of oil. If you’re a long-term bull on the commodity like I am, Penn West looks to be a great way to play it.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nelson Smith owns shares of PENN WEST PETROLEUM LTD..

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