November 6, 2005
Investing
Today's Energy Stocks May Well Be Tomorrow's
By CONRAD DE AENLLE
A FUNNY thing happens to markets that seem able to move in only one direction: they start heading the other way. Oil and other energy commodities are the latest noteworthy examples.
Since peaking two months ago, the price of crude oil has fallen as much as 17 percent, and traded contracts for natural gas and unleaded gasoline have declined substantially, too. Shares of energy companies have been dragged lower, too; some are down by more than 20 percent.
Shareholders may wish to take their profits before the prices erode further, but many investment advisers make a persuasive case for holding firm. In this view, cyclical ups and downs will continue, but they are mere blips that do not fundamentally alter a very long-term upward trend in prices for energy commodities and stocks.
Demand for energy keeps rising while new sources of supply grow scarcer, a reality that is unlikely to change, some fund managers and market strategists say. Fossil fuels will eventually become too expensive for everyday use, but there will be good money to be made from producing whatever power source comes next, they predict. And many of the producers, they say, will be the same companies pumping oil today. The energy industry's knack for playing a long game, plotting strategy based on assumptions of economic, political and technological developments many decades ahead, makes energy stocks worth holding onto, the investment advisers say.
But they debate the best way to benefit from the industry's farsightedness. Some make pitches for the biggest of the big, like Exxon Mobil, an outstanding stock over the last 30 years, or for oil service specialists like Schlumberger, while others prefer more obscure exploration companies.
"Over the near term, I think it's going to be kind of a struggle because we have a lot of uncertainty in the marketplace in terms of G.D.P., consumer demand, geopolitical considerations, rising interest rates," James D. Wineland, manager of the $4 billion Waddell & Reed Advisors Core Investment fund, said of the sector's share-price performance.
But he pointed to the continuing imbalance of supply and demand and added, "If we look beyond that, I think there's a huge future for energy stocks because this is an issue that isn't going away." He has made a big bet on that future, placing about 20 percent of the fund's assets in energy, double the market weighting.
David Spika, investment strategist at Westwood Holdings in Dallas, an institutional portfolio manager with large energy holdings, has similar hopes for the sector.
"Even though we have seen a significant decline in crude, the structural supply-demand imbalance remains," he said. "Obviously you have to expect corrections from time to time."
A chronic imbalance would set energy apart from other commodities, whose prices tend to fall over time when adjusted for inflation, said Jeremy Grantham, chief strategist at the portfolio manager Grantham, Mayo & Van Otterloo. While ephemeral factors can cause cyclical gluts and scarcities of commodities, new production methods help to ensure that supply outstrips demand over the long haul - except in the case of energy, Mr. Grantham has come to believe.
"We're gung-ho about regression to the mean, so when prices rise a lot, we are expecting to go short and underweight," he said about most commodities and the stocks of their producers. Since the shortages of the 1970's, the average price of a barrel of oil has been $36 in today's dollars. Mr. Grantham said he expects the average price to keep climbing as what is left of the earth's supply of oil becomes harder to extract.
"I'm offering oil as an exception to the principle" of mean reversion, he said. "Having hunted high and low and never found a major asset class that went through a paradigm shift, I think oil is it."
If a paradigm shift is occurring, the investment masses are barely noticing. Tim Guinness, who manages the Guinness Atkinson Global Energy fund, among the best-performing equity funds this year, with a return of 61.4 percent through Thursday, points out that energy stocks as a group have doubled since crude oil reached a trough in 1998 at less than $10 a barrel.
At the bottom, he recalled, energy accounted for a mere 6 percent of the valuation of Standard & Poor's 500-stock index, compared with 27 percent at the peak of the oil boom in the early 1980's. Today, with crude around $60, energy accounts for less than 10 percent of the index.
One reason for the relatively underwhelming move in the stocks is that the run-up in energy commodities has been accompanied by higher production costs. "Margins have expanded, but not to the degree you might think," said Mr. Spika at Westwood.
As oil continues to be depleted, Mr. Guinness said, there will be "huge one-off gains that the oil companies will enjoy from the increasing value of the reserves they have at the moment." The downside, he said, is that oil from new discoveries "will increasingly be in countries where the governments won't let them own it."
One way for investors to get the best of both situations is to hold shares in smaller companies that develop oil and gas fields in "mature, safer places" like Texas and the Gulf of Mexico, he said. Some examples he mentioned are Devon Energy, Apache, Anadarko Petroleum, Chesapeake Energy and Newfield Exploration.
Mr. Guinness also likes some of the big integrated energy companies, especially Chevron Texaco, ConocoPhilips and Occidental Petroleum. But he steers investors away from the industry leader.
"Exxon Mobil trades at a premium multiple over the independents and smaller integrateds," he said. "I think this means investors should not invest in it. Since 1989 it is actually the weakest performer in growing earnings per share among the big oils. There is no clear evidence that Exxon Mobil is able to grow earnings faster."
Mr. Spika is also a fan of the explorers. "We don't think all energy stocks are created equal," he said. "We like the ones that are expanding production growth." Among the exploration companies, he said, Apache is a favorites.
THE energy sector is big enough to accommodate great differences of opinion, even among enthusiastic supporters. While Mr. Guinness's list of preferred integrated oil companies includes almost anything but Exxon Mobil, that company is Mr. Wineland's top choice.
"It's a pretty phenomenally performing stock," he said. "The company has about as good a management as there is in the industry in terms of doing the right thing, a combination of growing its business and taking care of shareholders. They're smart guys, astute at investing in projects that make money."
Among the major oil companies, Mr. Wineland said he also likes BP.
Mr. Guinness says he has been avoiding drillers and makers of drilling equipment because "I happen to think they're all quite expensive." But Mr. Wineland is happy to have them.
"We have fairly substantial investment in the oil service side," he said. "The outlook is awfully positive as far out as I can see." He especially likes Baker Hughes, Smith International, Schlumberger and Weatherford International. Of course, there is no way to know how the energy industry's future will play out. But Mr. Wineland says he does not expect the majors to sit on their hands as the world runs out of oil." Most of these companies will identify themselves as energy companies, not oil companies," he predicted. "They are all aware that they will have to move over time slowly into other things. All the majors will be involved in whatever comes next - fuel cell technology, hydrogen. The infrastructure involved in moving us down the highway - as it evolves, these companies will evolve with it." |
