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10 stocks to protect you if oil prices spike
A big run-up would almost certainly damage the global economy and markets. These energy stocks look better the worse the turmoil gets.
By Michael Brush
While most investors worry about terror strikes, there are actually other big geopolitical threats out there that could damage your stock portfolio.
At four flashpoints around the globe, political tensions could heat up at any point and send the price of oil through the roof.
This could hammer your portfolio as investors likely would dump stocks for fear of the damage that high energy prices would inflict on the fragile economic recovery.
Fortunately, certain stocks will serve as excellent insurance for your portfolio in this scenario. The best hedge? Energy stocks, of course, because many of them will do quite well if oil spikes. So theyll offset losses in other stocks.
We found 10 of the best, and well get to those in a moment. First, heres a look at the four geopolitical flashpoints that could ruin your stock portfolio if you dont have the right insurance.
Challenges to the House of Saud
Not only is this the largest oil producer in the Organization of the Petroleum Exporting Countries (OPEC), this U.S. ally also controls nearly half of OPECs unused capacity, which now sits at a relatively low 2.2 million barrels per day.
Any serious crisis for the Saudi ruling regime would send shock waves through all oil markets. It could easily drive crude into the mid-$40 range, from recent levels of $33 per barrel.
What might go wrong for the Saudi ruling elite? The royal family that runs the country faces three basic threats.
Above all, al-Qaida is on a campaign to bring down the House of Saud. Thats the conclusion, anyway, of a Central Intelligence Agency (CIA) report that surfaced in the press on the heels of terrorist bombings in the country last year.
Next, despite the massive amount of money Saudi Arabia makes from oil, the country is in the throes of an economic crisis. For years, the population has grown rapidly, but national income has stood still. Theres been scant investment in the kind of businesses that produce jobs, says an analyst at a prominent think tank following the Middle East. (Most university grads arent prepared for a modern job market because many study subjects such as religion.) The result: a pool of young, disgruntled Saudis ready to lend a hand to regime change.
The younger generation wants things the way the older generation has it, and the Saudis simply cant afford that, says John Segner, who follows the intricacies of Middle Eastern politics as the portfolio manager of one of the leading energy funds, Invesco Energy (FSTEX).
That brings us to the third problem: Rising tensions among various factions inside the House of Saud create a heightened sense of instability, especially given all the other challenges.
It's more than conceivable that a radical regime could replace the House of Saud. But it would still have to sell crude to the West. Such a change still could disrupt supply or leave doubts in the market about how much the country would cooperate to stabilize oil prices -- a role Saudi Arabia has gladly played to date.
One more thing about that Saudi oil, so crucial to the world markets: If Iraqi insurgents can attack oil pipelines in Iraq so easily despite the big U.S. military presence there, terrorists could also attack the Saudi oil infrastructure.
Political unrest in Venezuela
With the potential to churn out more than 3 million barrels of crude a day, Venezuela is an important oil producer. Unfortunately, the country is just a step or two away from political chaos. Opponents of President Hugo Chvez are running a recall referendum against him and more than two dozen lawmakers aligned with him.
If they fail, will they resort to widespread strikes in the energy sector, as they have before? Or another military coup? Who knows. But the unrest in this country could easily bubble over and bring new disruptions in the flow of oil.
Russia-U.S. rivalry in Georgia
Halfway around the world under the Caspian Sea in Kazakhstan lie rich oil reserves that have hardly been exploited. These reserves could easily match the supply from Venezuela some day. One big obstacle: getting this crude to a port on the Black Sea so it can make its way to the West.
Russia wouldnt mind having the pipelines run through its territory. That way, it could exact a toll and exert a measure of control. But for security reasons, the United States wants to cut Russia out of the loop. Instead, it prefers a pipe across the former Soviet state of Georgia, after a brief pass through the neighboring country of Azerbaijan on the Caspian Sea.
But theres a big problem with this. Historically, Russia has been very sensitive about foreign powers setting up camp in countries near its borders. (Georgia is said to have the biggest CIA outpost in the world.) So naturally Russia sees U.S. entanglement in Georgia as a major threat, says Stephen Cohen, a professor of Russian studies at New York University. In the last few years, the U.S. government has adopted the attitude that Georgia now belongs to the U.S., he says. It has become obscenely provocative.
Even though you dont hear about this potential problem on the evening news, at some point these tensions may boil over in a big way. Georgia could become the place for a major conflict between the U.S. and Russia, one that might come very close to being another Cold War, Cohen says.
Those are strong words. But Cohen is a leading expert on the region, one who has followed the politics there for several decades, previously at Princeton University. This kind of conflict would not only throw Caspian oil supplies into doubt. Just as importantly, it would create the kind of global uncertainty that spooks the oil markets.
Class struggle in Nigeria
Another major oil supplier, Nigeria faces the risk of strikes by energy sector workers who dont think theyre getting their fair share of the oil wealth. These are people who are dirt-poor, working in tough jobs, and they see the top people rake in most of the oil wealth in the nation, says one oil-sector analyst. Nigerian oil companies could face strikes as soon as later this month.
Of all the geopolitical flashpoints that could wreak havoc in the oil markets, Nigeria is the smallest one to worry about, says Tom Petrie, of Petrie Parkman & Co., the Denver brokerage and investment bank that specializes in the energy sector. Nigeria is not minor, but the world has become used to Nigerian interruptions, he says. Serious instability in Saudi Arabia is the worst threat, Petrie says, capable of spiking oil well above $40 a barrel. But any combination of the other three could get us there, too.
The energy hedges
To find the best energy stocks to serve as a hedge against a crisis in the oil market, we looked for three things.
- Energy companies where insiders are buying significant chunks of shares in their own companies
- Energy companies with good earnings estimate revisions -- a sign of better growth ahead
- Suggestions from top energy sector analysts such as Petrie and Segner, whose Invesco Energy fund is up 14% annualized over the past five years (Those results far outstrip a 1.13% gain for the group over the same time frame.)
The 10 energy companies we came up with are worth holding even if you arent looking for a hedge against an oil price spike. Theyre all riding positive trends that suggest further gains for their stocks, even if oil does not spike.
Some of these are natural-gas plays, but thats OK. The price of natural gas tends to move in line with the price of oil, so theyll go along for the ride.
Following are our 10 picks.
| 10 energy stocks to weather oil price increases | | Company | Jan. 13 price | Company | Jan. 13 price | | BP (BP, news, msgs) | $49.40 | Harvest Natural Resources (HNR, news, msgs) | $11.00 | | Total (TOT, news, msgs) | $91.20 | Plains All American Pipeline (PAA, news, msgs) | $33.40 | | Murphy Oil (MUR, news, msgs) | $65.67 | Delta Petroleum (DPTR, news, msgs) | $7.67 | | Westport Resources (WRC, news, msgs) | $30.80 | Cheniere Energy (LNG, news, msgs) | $13.35 | | Contango Oil & Gas (MCF, news, msgs) | $6.58 | MarkWest Energy Partners (MWE, news, msgs) | $39.15 |
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BP and Total: The favorite of Invesco's Segner -- indeed, his biggest holding -- is BP (BP, news, msgs). He likes it in large part because of the joint venture BP created with the Russian oil company TNK. In the joint venture, the two companies have merged their Russian assets. This will give BP the opportunity to increase its annual production by 5% to 7% for the next several years. BP also has exposure to the North American natural gas market, where prices are skyrocketing due to underlying shortages that arent likely to go away soon. BP stock is also cheaper than that of other majors, and it pays a dividend yield of around 3.5%. Segner also likes Total (TOT, news, msgs), the French oil giant, in part because it has promising reserves in West Africa.
Among the big integrated oil companies, its best to avoid the likes of ChevronTexaco (CVX, news, msgs), which has more exposure to downstream revenue from refining and marketing. Instead, favor those with upstream exposure, like BP and Total SA. Their tilt towards production means an oil price spike -- increasing the value of their reserves -- helps them that much more.
Murphy Oil and Westport Resources: It pays to move down the market-cap scale in the energy sector. Smaller companies benefit more from lucrative finds, because they havent gotten so large that they are too big to grow.
Murphy Oil (MUR, news, msgs), for example, is big enough to qualify as a significant producer, but the El Dorado, Ark., company is small enough to pack on major growth. Where will it come from? A few years ago, Murphy was clever enough to snap up some of the richest reserves in the world, in the Sabah Trough off the north coast of the island of Borneo in Malaysia. Murphy has world-class exploration exposure, with good early success in offshore Malaysia, says Petrie.
Segner counts Murphy among his top five holdings for the same reason -- those reserves near Malaysia. And he also likes Westport Resources (WRC, news, msgs), which has a good track record for buying natural gas fields in North America without taking on too much debt or letting costs get out of control. The company trades at a 20% discount to its peers. But production should increase by 24% in 2004, says Merrill Lynch, which recently picked up coverage of the stock.
Contango Oil & Gas: Here's a small company with big growth prospects. Tiny Contango Oil & Gas (MCF, news, msgs), with a market cap of just $62 million, is out in front on a trend that has oil companies moving further offshore to exploit reserves. Since the easy pickings are gone in North America, many oil and gas companies are turning to reserves more than 15,000 feet deep beneath the Gulf of Mexico. This is kind of a new horizon, says Kenneth Peak, chairman and CEO of Contango.
His company has rights to drill in several areas of the Gulf of Mexico, as well as in south Texas. And it has a share of a liquefied natural gas (LNG) receiving terminal set up by Cheniere Energy (LNG, news, msgs) in Freeport, Texas. Peak must be pretty confident that Contangos assets will produce healthy profits. In the past 18 months, he has put $450,000 into stock of his company. He plunked down $130,000 in the past few weeks to buy shares at around $7, above current prices in the $6.80 range.
Harvest Natural Resources: On the heels of a major management change that played out in 2000-01, Harvest Natural Resources (HNR, news, msgs) has cleaned up its debt problems and trimmed costs. Now, more of the profits from gas and oil reserves it will be exploiting in Venezuela and Russia will fall down to the bottom line.
This year, production will increase 50% to 75%, says Chief Financial Officer Steven Tholen, and cash flow will rise 75% to 100%. Beyond that, the company will grow through more acquisitions. Insiders were buying back in late November at around $7, and the stock recently traded above $10.
Plains All American Pipeline: As the name suggests, Plains All American Pipeline (PAA, news, msgs) runs crude oil pipelines throughout Canada and the United States. But the Houston companys main focus is in the Midwest. Thats key, says Patrick Diamond, who handles investor relations for the company. Crude production is declining in that region. But demand there is increasing. So, more crude has to be imported -- through this companys pipelines.
Plains also has a big storage facility in Cushing, Okla., one of the nations biggest gathering hubs for oil and gas. Storage capacity in general is declining as old tanks fail to pass inspections. That means there will be more need for the Plains storage tanks in Cushing, says Diamond. Insiders were snapping up lots of shares in mid-December at around $32, according to Thomson Financial data.
Delta Petroleum: Shares of Delta Petroleum (DPTR, news, msgs) rose 25% last week to trade above $7.50 when a brokerage picked up coverage of the stock. But it will trade even higher over the next year, for two reasons. First, the company has been finding rich reserves in its oil fields, which are scattered in 14 states and off the coast of California. And there is more to come. Delta has a number of projects that could each potentially increase its reserve base 50% to 100%, says Michael Bodino, an analyst with Sterne, Agee & Leach, the Birmingham, Ala.-based investment house.
Next, at some point, Denver-based Delta likely will get a windfall from a lawsuit settlement -- one worth more than $4 per share. Through an acquisition, Delta Petroleum picked up the rights from the federal government to drill at several sites off the coast of California. But then the government changed the rules in a way that now makes it impossible to drill at those sites, says the company. So Delta and several other oil companies want back the money they paid for the leases.
Chances are good they will get it, because courts have ruled this way in similar cases. The $4 per share that Delta may eventually get out of this isnt factored in to the $10 price target that Sterne, Agee & Leach has for the stock.
Cheniere Energy: In the past few years, Cheniere Energy staked out some of the best potential sites in Texas and Louisiana for terminals that can receive LNG from other countries. Now its lining up partners to help fund construction of the terminals. Each financing deal will confirm Chenieres business model for investors, and drive shares higher.
The stock rose to $12 from $7 last month when ConocoPhillips (COP, news, msgs) signed on to help fund a terminal at Freeport, Texas. That deal will bring Cheniere $21 million in annual cash flow from LNG that's run through the Freeport terminal after 2007.
If successful, the two other terminals Cheniere wants to develop could bring $150 million to $200 million in additional cash flow by 2007 or 2008, suggesting considerably more upside for this stock.
Markwest Energy Partners: MarkWest Energy Partners (MWE, news, msgs) runs pipelines and processing centers that handle natural gas in North America. Because it is small, its strategy of buying other small operators around the country produces healthy growth. Insiders think even more is around the corner, because they were buying shares at around $39 in mid-December.
If you buy any of these stocks, keep in mind that energy prices are unusually high right now. That means they could pull back -- especially during the second-quarter lull between the heating season and the summer driving season, says John Lichtblau, chairman of the Petroleum Industry Research Foundation in New York.
That would likely spark a sell-off in energy stocks. But Invescos Segner isnt convinced a fall in the U.S. price of crude oil to the upper $20-per-barrel range would do much lasting damage. Generally, the higher price of oil is not priced into these stocks, he says.
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