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10 stocks that win with $60 oil
The price isn't just a number. It's shorthand for permanently high costs and soaring global demand. That means big opportunities for companies that can develop new resources efficiently.
By Jim Jubak
Sixty-dollar-a-barrel oil. It's different this time.
And investing as if this was just another temporary hike in the price of a barrel of oil isnt going to cut it over the next decade. In this column, Im going to give you my take on how $60 oil has changed the game for investors. And 10 stock picks for winning this new game.
Its not so obvious in the short run that the game has changed. In the short run, that $60 figure is just a price. But -- at least in the short run -- it's a price that moves the financial markets and the economy. When daily oil prices break below $60, stocks rally. And when crude moves strongly above $60 a barrel, stocks retreat. Check out the action on March 2 to see what I mean: A jump in the April crude-oil futures contract in New York to $63.36 that day helped the Dow Jones Industrial Average ($INDU) to a 28-point stumble.
Investors and traders are familiar with this kind of pattern and the factors -- such as seasonal fluctuations in inventory and market reaction to news -- that produce these moves. In the short run, although the price swings may be more extreme, $60-a-barrel oil is business as usual.
In the long run, though, $60 oil is shorthand for a set of changes in the global economy. I spelled out some of those changes in my March 3 column, Oil producers reach for more power. And Ive written about others -- ranging from peak oil to the rising cost of finding and producing oil -- in previous columns.
What $60 means
To sum up, briefly:- $60 oil is shorthand for an increase in the already substantial economic clout of oil-producing countries and a further decline in the independence of the global oil companies.
- Its shorthand for rising costs of production, as oil-producing countries charge more for access to their oil and as it gets more and more expensive to produce oil from aging or unconventional fields.
- Its shorthand for the growing importance of technology in the energy sector, as oil producers of all stripes struggle to wring oil out of old or damaged reservoirs or out of difficult-to-reach reserves -- and as every producer tries to control costs.
- Its shorthand for increasing demand from China and India that will keep supply too close to demand for comfort. It will thus magnify every minor geopolitical ripple, such as a regional war in Nigeria, into a market-moving event.
- Its shorthand for the increasing political uncertainty of supply, as the world becomes increasingly dependent on oil and gas from countries such as Russia, Iran, Nigeria, Venezuela and Saudi Arabia that are each ruled by regimes that are themselves dependent on oil-and-gas revenue to maintain their power.
And most of all, $60 oil is shorthand for permanently high energy prices. Oh, maybe not at the $60 level if the worlds economy slips into recession or if the worlds consuming countries take strong action to reduce their demand for oil and gas (Hey, dont laugh. It is theoretically possible.) But, nonetheless, crude oil permanently priced above the $45-a-barrel point makes so many new energy sources and energy technologies viable investments.
Related news and commentary on MSN Money
10 for $60
Let me translate three parts of that $60-a-barrel shorthand into longhand and give you a few specific stock picks for each part of this new global economy.
Lower royalties and greater political stability give a big edge to North American energy producers. At a time when energy-producing countries such as Venezuela are raising the royalties that oil producers must pay on each barrel they pump to 30%, the United States is headed in the other direction. Thanks to legislation passed during the Clinton administration and never revised, oil companies pumping oil and gas from federal lands will get about $7 billion in royalty relief between now and 2011. The problem, first exposed by The New York Times, is the result of incentives designed to encourage expensive deep-sea drilling in the Gulf of Mexico when oil was selling for less than $20 a barrel. But the royalty relief, which covers all drilling leases from 1996 through 2000, is still in place, even though oil is selling for more than $60 a barrel. Add in the relative predictability of U.S. and Canadian law -- nobody is about to seize domestic oil projects belonging to ExxonMobil (XOM, news, msgs) -- and domestic producers have a big edge on costs and reliability of production. This hasnt been lost on oil and gas companies: EnCana (ECA, news, msgs), the Canadian-based oil-and-gas producer, has been busy selling off foreign reserves in order to invest in North American projects, for example. Big winners from this North American edge include EnCana, Canadian oil sands producers such as Canadian Natural Resources (CNQ, news, msgs), and companies such as EOG Resources (EOG, news, msgs) that are tapping into the huge Barnett Shale formation in north central Texas.
Oilfield technology spending will rise faster than oil production. Spending money on technology makes sense in a $60-a-barrel world in two ways. First, spending money on technology can drive down overall costs. 3-D seismic imaging, for example, costs more than older forms of geologic data collection and display, but it more than pays for itself in improved rates of oil discovery. Second, new technologies for oil production can improve the rates of recovery from existing fields and make production from unconventional formations such as oil shale, oil sands or tight sand possible for the first time. Technology winners include Schlumberger (SLB, news, msgs) in seismic imaging and oilfield production management, Grant Prideco (GRP, news, msgs) in the development of intelligent drilling systems, Headwaters (HW, news, msgs) in researching ways to turn coal into oil and gas, and Praxair (PX, news, msgs) in the production of gases such as hydrogen used to increase production from aging fields.
The technology push from $60 oil isnt limited to the oil fields. A price above $45 is enough to power a search for new alternatives to oil and natural gas. Solar, ethanol, biodiesel, wind, nuclear and conservation are all candidates for the future energy mix. Which of these alternatives will grab the biggest share depends on technology. The biggest bottleneck in solar, right now, isnt a lack of subsidies or the price of solar-produced electricity, but the availability of enough silicon solar cells. With wind power, theres a race to make wind-turbine blades stronger, longer and lighter. In looking for a replacement for the gasoline-powered car, battery technology will be a key. And I dont think you can count out the old-fashioned internal combustion car just yet. Better computerized controls, better transmissions and other technological improvements could make the current auto more than a match for any hybrid. A study by the Union of Concerned Scientists, for example, was able to rebuild a Ford Explorer to get 36 miles per gallon, a 71% improvement. I think were looking at a golden age for materials science. I cant do more than scratch the surface here -- Ill return to this topic more fully in a later column -- but some companies that deserve a place on your radar screen include DuPont (DD, news, msgs), which has set a goal of making 25% of its chemical products from biological raw materials by 2010; General Cable (BGC, news, msgs), which is producing new types of electric transmission cable to address a huge conservation opportunity (distribution losses in the U.S. electrical grid have climbed to 9.5% today from 5% in 1970); to Zoltek (ZOLT, news, msgs), which makes high-performance carbon fiber used in autos and windmills to lower weight and increase strength.
Small government
Readers who have been paying attention will note that Ive now written two columns about solutions to the global imbalance between oil supply and oil demand without mentioning a single action on this front by the U.S. government.
Thats because, frankly, I dont expect this administration or any likely successor administration to do anything significant to address the situation. (The Clinton administration didnt do much on this front, either, so my disgust is resolutely bipartisan.) The forces of the status quo give too much money to too many politicians to make change likely. This is, after all, a government that hasnt been able to raise the corporate average fuel economy (CAFE) standards for passenger cars -- now at 27.5 miles per gallon -- since 1985.
Not that I wouldnt like to see the government act. I think government has a critical role to play in smoothing the transition from our current auto technologies to whatever comes next. And some mornings when the sun is especially bright, or the breeze especially fresh, I actually imagine that the government might act.
As an investor, though, Im not counting on it.
New developments on past columns
5 growth stocks for a weak-kneed rally
Pentair (PNR, news, msgs) turned in very solid earnings for the fourth quarter of 2005 and very encouraging guidance for 2006 -- even if the good in the news for 2006 wasn't immediately apparent. For the fourth quarter of 2005, Pentair reported organic revenue growth (that's growth before acquisitions) of 11%, with water revenues up 11% and electronic-enclosure revenue up 13%. Gross margins climbed to 28.4%, up 0.3 percentage points, and operating margins rose to 9.7%, from 9.5% a year earlier, once you backed out the effect of stock-option expenses in 2005. That increase was especially impressive given the growth in research and development spending at the company. The company lowered guidance for 2006 -- and ordinarily that would have tanked the stock. But the company noted that the decreased projections are due to heavy spending on new products and headcount (the company has doubled its headcount in China and now has 100 engineers in India) in the first half of the year. That should start to flow to the bottom line in the second half of the year. That's a continuation of recent patterns, which saw new or modified products contribute 4 to 5 percentage points of the company's 11% organic sales growth. Profit margins in the water business should improve as 2006 rolls along to produce growth closer to 18% than the 12% predicted by the current Wall Street consensus. As of March 7, I'm raising my target price on Pentair to $47 a share by September 2006, from the previous target price of $36.80. (Full disclosure: I own shares of Pentair in my personal account.)
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Encana, EOG Resources, General Cable, Grant Prideco, Pentair and Zoltek Companies. He does not own short positions in any stock mentioned in this column.
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