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5 energy plays for a long-term oil rally
We may be in a short-term decline in oil prices, but a long-term bull market in oil and energy is only just beginning. Here are 5 stocks to help you pump out the profits.
By Jim Jubak
Is this the end of the oil rally? Have the price of a barrel of crude and shares in oil companies finally cracked after rallying for months? Should investors sell? Hang on? Buy more?
In the short term, it looks like were in for oil prices around $47 a barrel and perhaps even lower. Some Wall Street oil analysts are predicting prices in the low $40s. In the short term, prices of oil stocks, which havent moved anywhere since they peaked around Oct. 6, will, at best, stay stuck in that rut. At worst, theyll move lower with the price of the commodity they sell.
In the long term, however, were near the beginning of a bull market in oil and other forms of energy -- and in the shares of the companies that drill, pump and mine.
The trick is figuring out where the short-term decline will end and where the long-term rally will kick in.
Heres my take on separating the short- and the long-term strategy for oil, and five stocks for playing both strategies.
Making sense of the price action
Lets start with recent price action in the oil-futures market. Oil for December delivery fell below $50 a barrel on Nov. 2 for the first time in four weeks. After trading at an all-time high of $55.67 just days ago, the December futures closed at $49.62. The next day, oil dipped even lower to $48.65 before closing at $50.88.
Whats behind this price action? On Nov. 3, the Department of Energy reported that crude oil inventories in the United States rose by 6.3 million barrels in the week and ended the period just 2.2% below the five-year average for crude oil supplies. That was a huge improvement from six weeks ago, when inventories were a scary 8.1% below the five-year average.
Inventories jumped in part because additional supplies promised by the Organization of Petroleum Exporting Countries (OPEC) earlier this year began arriving in the United States in significant volumes.
The rest came as pipelines damaged by Hurricane Ivan came back on line and oil flow from the offshore platforms in the Gulf of Mexico continued to increase. The Minerals Management Service of the U.S. Department of the Interior estimates that about a third of production that flows through the damaged pipelines was likely moving again by the end of October. The remainder could take as long as six months to restore. Production from fields in the Gulf of Mexico is particularly important to the U.S. oil market because it is made up of low-sulfur grades of crude that are hard to replace from sources in the Middle East.
For the next six months, increasing production of low-sulfur grades of oil from the Gulf should allow inventories to rebuild. That, in turn, should put downward pressure on prices. Wall Street also assumes the Bush administration will reintroduce legislation to increase domestic drilling activity. Add to that mix the unwinding of speculative long positions by oil traders who are wary of Chinas slowing economy and the math suggests six months or so of moderating prices for oil and oil stocks.
Supply not increasing quickly
But nothing in that calculation changes the long-term supply/demand picture for oil and natural gas. As the recent quarterly reports of the big integrated oil producers show, supply isnt growing quickly and these companies dont seem in any hurry to invest in increasing production, even with oil near $50 a barrel.
Related news and commentary on MSN Money
Look at Exxon Mobil (XOM, news, msgs)s third-quarter numbers, for example. Earnings and revenue soared on higher oil prices, but oil production rose a piddling 1% from the third quarter of 2003. New production from West Africa and Norway barely kept the company ahead of declines in production from older fields. Its a similar story with natural-gas production: a 1.3% increase. Exxon said that it remains on track to a 3% increase in oil and gas production in 2004, and its projecting 3% annual increases in production for the rest of the decade.
With oil prices so high and production increases so paltry, you might expect Exxon to be pumping up its budget for exploration and production. But the companys capital spending actually fell 5.5% in the quarter to $3.6 billion from $3.8 billion, compared to a year earlier. For the year, the company expects that capital spending will be flat with 2003 spending of $15.5 billion.
Its story isnt unique. BP p.l.c. (BP, news, msgs) announced higher earnings for its third quarter -- net income almost doubled -- but said that capital spending would be essentially flat in 2004 once you corrected for rising costs and a falling dollar. The boost to $14 billion in 2004 from $13.5 billion in 2003 is almost totally the result of inflationary pressures that are driving the costs of leasing drilling rigs and buying drill pipe up by about 10% a year.
Oil and gas production at BP climbed by 11% in the third quarter of 2004 from that same quarter in 2003, but most of that gain came from the companys purchase of a 50% stake in its Russian joint venture TNK-BP. Excluding production from that joint venture, production was up 5% year to year.
A move to the sidelines?
These oil companies are raking in record numbers of dollars. So why arent they spending it on exploration and production instead of spending it on buying back shares? Some of it is due to the innate conservatism of these companies. BP is just now getting around to using a price of $30 a barrel in thinking about what new projects might justify their costs. But a big part of it is the difficulty of finding new supplies of oil and gas -- at least new supplies in countries that will let big multinational oil companies drill and pump rather than reserving those functions for state-owned companies. Longer term, that means continued upward pressure on oil prices because the next decade will see rapidly rising demand but a slowly growing supply.
In the short term, the wisest investment move might be to step to the sidelines (or stay on them) while the good news on supply works its way through the markets over the next six months. Theres a good chance that oil stocks could be trading modestly lower. If youre a long-term investor holding oil stocks in a taxable account, its probably not worth selling and creating a taxable event. Instead, make your profits in the end-of-the-year rally in other sectors and look to redeploy those profits back into energy stocks in February or so.
5 stocks to watch
The drilling and drilling-services sector is an exception to that advice. Remember that the oil companies are complaining about the rising costs of rigs, pumps and pipe. Those extra costs are turning into extra revenue for the drillers and service companies. And that extra revenue (and earnings) is likely to show up in the fourth-quarter earnings statements of companies such as Transocean (RIG, news, msgs) and Diamond Offshore Drilling (DO, news, msgs). Both stocks are currently rated 9 out of a possible 10 by MSN Moneys StockScouter.
Also, keep in mind that a barrel of oil produced in 2014 is likely to sell for a lot more than a barrel pumped in 2004. It doesnt hurt if a company is showing growing reserves as well. Here are three others to consider:- ChevronTexaco (CVX, news, msgs). The company turned in disappointing results in the third quarter of 2004, due to its high exposure to the Gulf of Mexico and production shutdowns caused by Hurricane Ivan. The $1.28 a share reported in the quarter was well below the Wall Street consensus estimate of $1.38. But Chevron is the most back-end loaded of all the multinational majors in the oil industry. Production volumes are likely to be flat through 2005, calculates Lehman Brothers, and then will begin to increase in 2006 and 2007 as new fields come on line. The companys new Angola fields, for example, dont begin production until late 2004, with the bulk of new production falling after 2006. The companys biggest field in Kazakhstan, Lehman projects, wont start production until 2010 and wont peak until 2013.
- BP. Thanks to its joint venture, TNK-BP in Russia, BP has access to vast underperforming oil fields. These fields have been mismanaged and BP can readily increase production by investing in better equipment, applying newer techniques for oil extraction and reserve management, and by better oversight of the wells. BPs ability to successfully operate in the volatile Russian oil industry, where the rules of doing business can change with that days ministry decree, could also give the company an edge in bidding on other Russian oil projects if and when the Kremlin decides to reverse course and encourage more foreign ownership or management of the countrys energy resources.
- Suncor Energy (SU, news, msgs). This Canadian company is set to more than double its production for its oil-sands operation by 2013 to 550,000 barrels a day from the current 230,000 barrels a day. Add to that the companys continued investment in refinery capacity that will turn the very heavy, high-sulfur crude into sweeter grades with less sulfur content. As a result of that combination, Suncor is among the oil companies most leveraged to future high oil prices. Lehman calculates that for every $1 (Canadian) a barrel change in the long-term price of oil, the value of Suncors assets climbs $2 to $3 (Canadian) a share. Thats not surprising since Suncors operating costs of around $12 (Canadian) a barrel are substantially higher than the $6.34 a barrel in exploration and development costs and the $2.80 in lifting costs averaged by BP in the third quarter of 2004.
It may seem strange to be thinking about buying in anticipation of a renewed rally in the energy sector in 2005 even before weve seen whether my projected end-of-the- year rally in technology plays out. But thinking one rotation ahead has been critical to making money in the stock market in 2004. And I dont see 2005 turning out to be much different.
New developments on past columns
3 food stocks face a leaner, meaner world
Rule of thumb on Wall Street: After a company has warned on earnings, it doesnt take much good news to push up the stock. On Oct. 18, Performance Food Group (PFGC, news, msgs) warned that third-quarter earnings would be 37 cents a share, below Wall Street projections, and that fourth-quarter earnings would be just 30 to 34 cents a share, below the 35 cents a share Wall Street was projecting for the quarter. The stock plunged. On Nov. 2, the company reported actual third-quarter earnings of 37 cents, exactly on estimate, and the stock rallied even though earnings were 16% below the third quarter of 2003. Sales did rise 11% to $1.55 billion from last years $1.39 billion, and they came in slightly ahead of the Wall Street consensus of $1.52 billion. The problem in the quarter, as the company had warned in October, came in the fresh-packaged salad segment where growth was just 4%, well below recent trends. As of Nov. 5, Im keeping my target price at $34 a share by July 2005. (Full disclosure: I own shares of Performance Food Group.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Performance Food Group. He does not own short positions in any stock mentioned in this column.
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