Barron's article supports Slider's contention that we will correct further the next few weeks:
April 26, 1999
Crude's Winners
Price rise aids some sectors more than others
By Cheryl Strauss Einhorn
With oil prices having rallied 70% this year, to over $18 per barrel last week, it's no surprise
that shares of oil producing, service and refining companies have gained handsomely. But some
sectors are more sensitive to moves in crude than others.
In fact, while the oilfield-service stocks -- which have been the hardest-hit since late 1997 -- have
gained the most, rising on average 54% since the beginning of March, this group actually is the
least sensitive to rising petroleum prices.
Instead, the service stocks are driven by expectations for capital expenditures; they gain only after
the drillers have benefited. But given that energy prices were so depressed last year, capital
expenditures are dormant. And despite this year's run-up in crude, producers aren't opening their
wallets. For companies like Exxon and Chevron, first-quarter capital spending declined by 10.5%
-- a percentage in line with expectations for an upstream decline in spending of 19% this year,
versus 1998's level.
The exploration and production companies won't begin to put together their budgets for the year
2000 until late summer or early autumn. Even then, any increase in outlays is likely to be modest.
Spending will hinge on how stable oil prices appear to be, and also on how the rest of the industry
is doing.
Result: "After the run-up, we believe the stocks could give up some of these gains," says James
Stone, a managing director at Schroders. "They are very volatile and the near-term landscape for
service activity and pricing is awful and will lead to disappointing earnings. But the bottom has
been seen and we expect these stocks to move up longer-term."
The outlook now is much brighter for the drillers themselves. Integrated companies, such as Arco
and Mobil, are the most directly affected by price changes. A $2 move from, say, $16 to $18, adds
30% to earnings. Hence, despite a 27% gain in the group's shares since March, many of these
companies' stocks don't reflect today's higher prices, says Paul Ting, an oil analyst at Salomon
Smith Barney.
Indeed, consensus earnings forecasts for the drillers haven't been raised. "The estimates are still
too low by 30% and 20% for '99 and 2000, respectively," maintains Ting, who adds that "the
major [oil companies] are discounting $16 oil. At [today's] $18, expect 15% outperformance in 12
months."
Essentially two types of drillers may benefit: real oil companies like Texaco, YPF and Arco, and
the cost-cutting and merger types like Mobil, Exxon and BP Amoco.
Many of these outfits are expected to announce earnings this week. Ting expects that "after they
announce, earnings estimates will be ratcheted up across the board." Right now, the consensus
1999 earnings estimate for companies in an index that Ting has compiled is $23; he thinks $30
might be more appropriate.
For example, Texaco is expected to earn $1.86 per share this year. Ting is looking for $2.70.
In addition, it's likely the crude price used in calculating earnings forecasts will be raised. While
consensus estimates for the first quarter were $11-$12 per barrel, West Texas Intermediate spot
prices actually averaged $13.19. The consensus price for all of '99 is still $14.28 per barrel, but
this probably will climb, pushing up energy companies' profit forecasts ... and shares.
As for the refining stocks, although it may sound odd, historically they have benefited from a rise
in oil prices.
However, because the refiners' stocks already have done well, rising 30% on average since
yearend, they may be fully valued now. Despite rising energy prices, it is seasonality and not a
secular change in oil's fundamentals that drives refining margins.
Refining margins tend to peak between April and May, as more refineries shut down for
maintenance in spring than at any other time of year, while demand continues to be strong. This
year, given that inventories of crude and refined products remain swollen, the number of
shutdowns in the U.S., Canada and Europe will be quite high. They will affect almost one million
barrels a day, versus 570,000 during the corresponding stretch last year.
The closures temporarily tighten supplies and boost margins. Since the shares track margins
closely, "investors may look for peaks in these stock prices in the next month," says Ting. |
