Energy Insiders Head for the Exits
By Kristina Shevory
TheStreet.com Staff Reporter
8/30/2006 7:48 AM EDT
URL: thestreet.com
Until very recently, buying energy stocks seemed like a sure thing. Share prices kept rising as oil companies reaped record profits off sky-high gasoline and crude prices.
But even as crude futures were hitting all-time highs this summer, energy insiders were selling their shares in record numbers, according to a study by the Leuthold Group, an investment research firm in Minneapolis. Sales hit an all-time high in May among a group of 142 energy companies the firm follows, and they have remained high since then.
In July and August, Exxon Mobil (XOM) executives have sold more shares than in the previous two quarters combined, according to Thomson Financial. In July, executives at refiners such as Holly (HOC) , Frontier Oil (FTO) and Sunoco dumped more shares than at any time since the Leuthold fund started tracking them seven years ago. (Bloomberg previously reported the fund's findings.)
"They're people you should tend to follow, rather than to take the opposite of their trades," says Andy Engel, a senior research analyst who co-manages the $2 billion Leuthold Core Investment fund. "What we are seeing is it's time to be out of the area."
Presuming executives know their company and industry better than outsiders, investors should pay heed to their actions. Engel certainly has: Since February 2004, he has ratcheted back the fund's holdings in energy from 15% to around 1% on the basis of insider trading levels, growth prospects, valuations and other factors. A lot of the fund's money has instead gone into cash to take advantage of high interest rates.
Ted Aronson, a portfolio manager at Aronson & Johnson & Ortiz, "explicitly considers insider selling" in his investment decisions, including the sale of 153,000 shares of Frontier Oil and 1.7 million shares of Sunoco in June. Market conditions, such as strict government standards for gasoline that started in May, also prompted the sale by the $26.1 billion Philadelphia-based money management firm.
"Despite everything going on, [insider activity] is still an effective measure on Wall Street," says Aronson.
To be sure, many insiders sell shares after record earnings results or all-time stock highs, or to reduce their risk and diversify personal holdings. Sometimes a flood of sales can mean executives are selling after a blackout period, a time when selling is prohibited around the release of significant news. Other times, it can mean that premiums, or the purchase price of an option, have hit a certain level and executives want to cash out.
Fundamental Divergence
"Selling is very difficult to use as a tool," says Mark Lopresti, a senior quantitative analyst who tracks insider sales at Thomson Financial in Rockville, Md. "You need to look at the fundamentals."
Still, some money managers have been getting out of energy because the only thing holding up the sector's record earnings has been lofty oil prices, which have started to lose altitude in the past few weeks. Energy executives, through their insider sales, could be pointing to a more sustained pullback in energy prices and related shares. Despite recent weakness, crude prices have risen 14.2% in 2006 as of Tuesday's close of $69.71, thanks to a flood of new money from institutional investors, production shortfalls in Nigeria, Iranian saber rattling and booming demand from Chinese, Indian and American economies.
But skeptics believe the run-up in prices can't be supported because crude supplies are rising and are now nearly 5% over last year, while demand growth is slowing. The naysayers believe oil prices are high largely because pension and hedge funds have poured billions into commodities over the past two years. This year, institutional money managers have funneled $100 billion to $120 billion into commodities, up from $6 billion in 1999, according to Barclays Capital.
If oil prices take a dive, as some analysts believe will happen next year, equity from exchange-traded funds and hedge funds could flow out as fast as it poured in. Without that money, experts say, oil prices could drop by as much as $25 a barrel.
"People think crude will go up and up and up. If the crude chart breaks down, you're going to see a run for the doors," says Ben Dell, an energy analyst at Sanford Bernstein in New York. "People have come to believe these earnings will continue, and that's dangerous in a cyclical industry."
Though the oil industry has been on an upswing for the past three years, it's notorious for boom and bust cycles. As profits have soared by as much as 50%, so have expenses. At many large oil companies, production is flat or falling, and excess cash is funneled into buybacks and dividends rather than exploration.
In the second quarter, Royal Dutch Shell's (RD) profits soared 36%, but daily output fell nearly 8% to an average of 3.25 million barrels. This year, production is expected to come in around 3.4 million barrels per day, nearly 6% below its previous forecast. Chevron's (CVX) quarterly profits climbed 18% to $4.35 billion, while production jumped over 12% to 2.7 million barrels per day. But the output increase was due mainly to Chevron's purchase of Unocal.
The specter of slower economic growth also threatens to crimp demand for crude. Lower building permits and housing starts have given rise to concerns of a housing slowdown and an economic downturn. The Federal Reserve's decision to pause its tightening campaign this month led some analysts to believe the economy will likely become sluggish in the months to come.
Despite the warnings, some investors are holding tight and expecting profits -- and share prices -- to soar even higher. They point to Americans' unquenchable thirst for oil and tight global supplies. While the world consumes about 85 million barrels of crude per day, there are only 2 million barrels of extra crude per day. In their view, oil prices are unlikely to drop anytime soon.
Commodities have attracted new investors who are eager to diversify their holdings and shore up their portfolios. Mutual funds and ETFs put $5.47 billion in energy futures last year, up from $407 million three years ago, according to AMG Data Services in Arcata, Calif. But the flood may be slowing because energy investments total only $2.17 billion so far this year.
"In general, there are a lore more reasons to sell than to buy," said Aronson.
Apparently, many energy insiders agree. |
