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3 oddball oil companies primed for profits
The heady rise in energy shares may be tapped out -- but these 'unconventional' producers could have another great year. Here are three to watch, plus two more mainstream picks.
By Jim Jubak
A year ago a barrel of crude oil (West Texas Intermediate grade crude, to be precise) sold for $49.56. A year later a barrel of West Texas Intermediate went for $65.83. Which oil stocks benefited from the 33% jump? Just about all of them. Any oil company with crude in the ground saw the value of its inventory leap. Even if a company didn't increase production by one barrel, revenue soared.
It was almost as good a time to own oil stocks -- any oil stocks -- as the prior year, when the spot price of a barrel jumped 76% from September 2003 to September 2004.
Now, though, I don't think investors can count on comparable future oil-price increases to lift all oil stocks. Another 33% increase, not to mention a 76% spike, would, most economists believe, produce an economic slowdown that would reduce demand for oil and send crude prices lower. The consensus on Wall Street is that we'll see oil prices drift near current levels for awhile as the economy adjusts to permanently higher oil prices. There are even Wall Street analysts calling for oil to drop back to $50 or even $40.
And that raises this question for investors: If rising oil prices aren't going to lift all oil stocks, is there a specific kind of oil stock that will outperform the sector and the rest of the market? (If not, then it's time to give the sector a rest and move on to more attractive situations.)
I think there is. The shares of what are called "unconventional" producers -- those companies that mine oil sands or oil shale or drill in rock formations that other companies won't touch -- still have at least another great year ahead of them. These stocks don't need rapidly rising oil prices to beat the market. Steady oil prices will do fine, thank you. The longer oil stays above $40 a barrel, the more credible the production and revenue projections of unconventional oil producers become and the higher their shares climb.
Rooting for more expensive oil
That's not because these unconventional producers are sitting on so much cheap oil. Exactly the opposite, in fact. It's because their costs for producing a barrel of oil are so high.
Here's how high production costs become an advantage. Consider one type of unconventional producer, one working in Canada's oil sands. The amount of oil locked up in these oil sands is huge -- enough so that they are estimated to hold 174 billion barrels of recoverable oil, the second largest reserve in the world next to Saudi Arabia. But to get the oil out you have to mine the sands, "boil" them to extract the oil that's mixed in, and then process it so that it can be refined by conventional refineries.
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All that costs lots of money. To dig the mine or steam the sand underground. To build the cookers and the processors. To pay for the immense volume of natural gas that is needed to cook the sands. To connect the oil sands mines with oil pipelines. Many unconventional producers are looking at production costs of $25 a barrel.
So think of the leverage that the shares of an unconventional producer gets when oil passes above that price. At $25-a-barrel oil, these unconventional producers are interesting "concept" companies: They may make money someday, but they certainly aren't making any now. (Break-even used to be estimated at $20 a barrel, but that was before the price of natural gas, the fuel used to cook the sands, soared.) Ramping up production doesn't help either, since more product is still sold at break-even. (That's especially true because many unconventional oil production processes are so new that a producer can't expect the economies of scale that typically come with increasing production.)
At $30, these unconventional producers are handsomely in the black. Suddenly, their shares are supported by revenue and earnings. At $40 a barrel, unconventional producers can easily tap the capital markets to raise the money they need to expand production, and then reap the higher revenues that result. And at $40, major conventional oil companies -- and sovereign countries such as China -- that are hungry for new sources of oil begin to acquire unconventional oil production companies. For example, Synenco Energy, a private oil company partnered with China's Sinopec, recently paid $76 million (Canadian) for 36 square miles of oil sands in Alberta.
This same leverage kicks in for oil companies producing oil from oil shale or by drilling deeper into more complex rock formations than most oil companies attempt.
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