How pricier oil can fuel profits - Money, November issue
By Michael Sivy
WHEN I FIRST began as a financial journalist in 1979,
oil-related stocks carried the kind of buzz that
Internet issues do today The price of crude was
soaring, heading above $30 a barrel. And high-powered
money managers talked about directional drilling and
three-dimensional seismic data the way they now go on
about chip speed and bandwidth. By the early '80s,
though, oil prices were sliding. And last year, oil
sank to less than $11 a barrel. Since the '70s, the
price has dropped that low (adjusted for inflation)
only one other time-in 1994.
Over the past 12 months, however, oil prices have
rebounded with extraordinary force, climbing to more
than $25. That stunning increase promises to have a
major impact on the economy and the market. Energy
sector funds are up nearly 50%, more than twice the
gain for the S&P 500.
The surprising thing is that despite the recent
volatility, the cost of oil has been remarkably stable
for nearly a century In fact, since 1900 the price of
oil has generall traded between $11 and $20 (adjusted
for inflation), with a median price of about $15. The
three main exceptions were the oil crisis-particularly
from 1978 though the early '80s-and brief upticks
after World War I and during the 1990 Gulf War.
The cost of energy has also been key to the health of
the U.S. economy. For instance, oil prices were fairly
stable from 1948 through 1957, an era of steady
growth. From there, they fell to a low of about $11 in
1972 and fueled the '60s boom. Then they soared until
1981, helping to create stagflation. From 1982 until
last year, the erratically declining price of oil was
a major contributor to the strength of the economy and
the stock market.
Oil may climb higher in the next year or two, or it
could drift back below $20 a barrel. But unless
there's a deep global recession, don't count on seeing
supercheap oil again anytime soon. And even $20 oil
will be a big burden for a market that's already
starting to run out of steam.
[Graph]
Caption: A NEW DRAG ON THE MARKET
[Photograph]
Caption:
Most energy stocks have run up and are no longer the
great deals they were in 1998 or even earlier this
year. In the March issue, for instance, we recommended
oil service giant Halliburton at $29.50. It currently
trades at $41, a gain of nearly 40% in just over six
months. Measured against the rigorous criteria I
describe in the Focus Investing story on page 106,
most leading energy stocks are too expensive now to be
the best choices for the long term. Nonetheless, they
may be good performers in the near term and could be
compelling buys after any major market pullbackas
could funds such as Fidelity Select Energy or Vanguard
Energy.
The biggest energy stocks fall into three categories:
international oils, providers of oilfield services and
major natural gas companies. In addition, there are
smaller companies that depend chiefly on producing oil
and gas; their fortunes are tied closely to energy
prices. In this category, I own Burlington Resources,
the second largest independent producer in the U.S.,
with proven reserves equivalent to some 8 trillion
cubic feet of natural gas. The stock is currently $36,
several dollars below where I bought it last year. The
company's production mix is 77% gas, which has lagged
the run-up in oil. In addition, Burlington has
temporarily cut back activity in the Gulf of Mexico.
Still, I think of it as a long-term option on energy
prices.
Exxon, which is in the process of acquiring Mobil, is
the natural choice among the internationals. But at
$75 a share, the stock is trading at nearly 25 times a
generous estimate of next year's earnings, which seems
steep for a company with a core growth rate of only 8%
(although it might do better if the Mobil merger
yields abundant costcutting opportunities). Chevron,
with equally sterling financials, offers a bit better
growth prospects and, at $88 a share, a slightly lower
multiple.
Among oil service stocks, Schlumberger and Halliburton
are the gems. As a rule, oil service stocks have more
leverage than producers, since drilling expands much
faster in a high-price environment than production
can. Both stocks offer double-digit growth potential
(Halliburton is actually growing a tad faster at 15%),
but their price/earnings multiples seem high at 30 or
more, based on next year's projected results.
Cooking with gas
Integrated gas companies may be the best longterm
plays. "U.S. demand for gas should increase an average
of 2.6% annually over the next five years," says
analyst Curt Launer at Donaldson Lufkin & Jenrette,
"while supply, including Canadian imports, should
increase only 2% to 2.5% a year." Launer picks Enron
as the most attractive stock in the sector. But even
with projected growth of as much as 15% a year, Enron
doesn't look cheap, given its 31 P/E based on earnings
for next year. Nonetheless, Launer thinks the stock is
still undervalued because of the worth of the
company's assets, including its energy services and
communications businesses. (To go along with its
natural gas pipelines, the company is building a
fiber-optic network.) And he believes the shares could
rise from $40 apiece to $52. That might turn out to be
more upside than Internet stocks offer from today's
levels.
[Author note]
Starting Nov. 1, Michael Sivy will be commenting on
market moves three times a week. On the Web at
money.com and by e-mail
Money
Volume: 28
Issue: 11
Start Page: 39-40
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