Jubak's Journal Recent articles: • A double hit to the Gulf -- and the economy, 9/27/2005 • How the Fed lost the inflation fight, 9/23/2005 • Katrina is no disaster for insurance stocks, 9/21/2005 More... | Jubak's Journal 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. More from MSN Money 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. Predictable oil, predictable profits These unconventional plays aren't just another source for oil companies hungry for oil wherever they can find it. Unconventional sources of oil are remarkably predictable. A company doesn't have to sink a test well into a promising geological formation and hope for profitable amounts of oil and gas. With unconventional sources such as oil sands and oil shale, the oil company knows the oil is there and ready for the pumping if they sink enough money into the project. This week on my regular Wednesday appearance on CNBC's "Morning Call" I recommended the shares of three unconventional producers. Quicksilver Resources Carrizo Oil & Gas Ultra Petroleum You'll note that all three of my picks for CNBC's "Morning Call" emphasize natural gas over oil and land-based gas production over gas from the Gulf of Mexico. That's because I think natural gas prices will go up faster than oil prices over the winter and through 2006. The recent hurricanes also are adding a "safety" premium to land-based natural gas production. That's why my two "exclusive" picks for readers of CNBC.com on MSN Money are both conventional gas plays. I think the fundamentals for natural gas companies, even if they're producing from conventional sources, will drive these stocks higher. Chesapeake Energy Burlington Resources Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. Please note that Jim's CNBC picks are short-term recommendations with a 6-month time horizon. For picks with a longer time horizon see the 12-to-18 month Jubak's Picks portfolio or his truly long-term 50 Best or Future 50 portfolios. You'll find links to all three at the left near the top of this column. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak did not own or control shares of any of the equities mentioned in this column. He doesn't own short positions in any stock mentioned in this column. | |||||||||||||||||
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