Oil is Down, But Don't Count It Out
By YOUSSEF M. IBRAHIM
New York Times, October 6, 1998
The world of oil may appear to be falling apart, but in oil things are never quite as bad or as
good as they seem. Huge mergers have thrown the industry into confusion as oil prices have
dipped to historic bottoms. Yet, if history is any guide, investors who write off energy will miss
opportunities.
True, there has been a wave of bad news: growth in demand has been tempered by the Asian
economic crisis, winters have been exceedingly mild and the Organization of Petroleum Exporting
Countries appears hopelessly unable to rein in production.
And yet, oil is a strategic commodity governed by some constants. "The oil business is a cyclical
industry, where prices will go up and down," said John Lichtblau, chairman of the Petroleum
Research Industry Foundation. "But oil is also a growth industry and an essential commodity."
If you have any doubts about the growth part, just consider what will happen when every other
Chinese and Indian family begins, sometime in the near future, to buy its own car, refrigerator and
air-conditioner. There may not be enough energy to satisfy demand in two markets that will have
more than a billion consumers each.
"Even now, all the bad news -- the mild winter, the Asian crisis and OPEC's problems -- are
one-time factors," said Ernst von Metzsch, a partner at Wellington Management, a Boston money
manager.
Worldwide demand for oil is expected to rise 0.5 percent this year, compared with an average
annual rate of 2.3 percent over the past decade. Regardless of the bad news and predictions that
West Texas Intermediate will soon trade in the middle single digits a barrel, many OPEC experts
expect oil prices to rise gradually to $17 a barrel within a year, versus $11 on Friday.
In other words, when it comes to oil, think long term. And, don't be surprised if oil prices double in
a relatively short period.
In the present atmosphere of excitement and confusion fostered by the recent Exxon-Mobil merger
announcement and the earlier British Petroleum-Amoco deal, the best strategy is to keep a fair
share of your energy portfolio in huge multinationals. Specifically, that means the big five: Exxon
Mobil, Royal Dutch/Shell, British Petroleum, Chevron and Texaco.
"This group of big international integrated companies is the most interesting right now," said Paul
Ting, an analyst at Salomon Smith Barney.
Ting predicts that Exxon's shares, now at $71.50, will hit $85 in 12 to 18 months, and that Texaco,
now at $56.3125, may hit $70 in that same period. For Chevron, the target price is $88, versus
$82 on Friday.
"Even if you misjudge the timing with this group, there is always another day," Ting said. "All of them
have over the past year cleaned up their balance sheet, bringing debt-to-capital ratios from 40
percent closer to 30 percent, and all are still in an acquisition mode."
With the big oil stocks, investors get paid to wait for any price rise. Exxon, Texaco and Chevron
have yields of 2.29 percent, 3.20 percent and 2.98 percent, respectively, versus just 1.31 percent
for the Standard & Poor's 500-stock index.
The integrated structure of these companies -- production, refining, and retailing as well as plastics
businesses -- gives them a measure of protection.
"This industry has a self-correcting mechanism," said Karl Bandtel, a partner at Wellington
Management.
Acquisition fever also provides opportunities. ARCO, for example, which has big oil reserves in
Alaska's Prudhoe Bay as well as oil and gas in Indonesia, is one possible target. Its shares trade at
$67, but Bandtel said they could climb as high as $80 the next 12 to 18 months even if ARCO isn't
acquired.
More risky are small independent United States exploration companies. Many of their stock prices
are off 50 percent or more the past 12 months. It's the same for oil-service industries like drilling
companies.
Weatherford International, for example, has fallen from over $50 a share a year ago to $17.50 on
Friday. Bandtel said, however, that it could double in a year if demand for services picks up, as he
expects it to.
Even now there are buys, mainly in companies largely involved in natural gas, which has fallen less
than oil. Alberta Energy, which trades at $21.3125, could hit $26 within a year, according to von
Metzsch.
In general, analysts and managers suggest avoiding higher-cost oil producers in North America --
there are scores of them in Texas, Oklahoma, California, Louisiana and Alberta. They may need oil
prices of $18 a barrel to make a profit -- a level that may not be seen for some time.
Two events to watch: the fourth-quarter earnings announcements of oil companies, coming in
January, and the OPEC meeting in late March. The former will show how well individual companies
are coping with low oil prices; the latter will show whether a seriously weakened OPEC has the will
to adopt a new strategy for cutting production.
But even if OPEC cannot discipline itself, some experts believe industry mergers and low oil prices
will help it, as small companies exit the business of pumping oil in expensive places like the United
States.
"If these mergers curtail production outside the OPEC area, they could in fact help, not hurt the
whole energy industry," said Nordine Ait-Laoussine, a Geneva-based energy strategist and a former
energy minister of Algeria. |
