I wouldn't go hog wild all in energy but I might consider overweighting it a bit.
Title: Do energy stocks have more upside?
Author: Steven Utley
From the surface, it would seem apparent that the run in energy stocks can't last much longer. After all, the S&P Energy Index has averaged an annual gain of 27.29% per year over the last five years. Does that mean
now it is time to take profits?
Using Value Line as a reference, I checked the price to earnings ratio (PE)of three stocks in each of the four energy sub-sectors to determine the P/E
for the last 10 years. In 11 of the 12 stocks I looked at, the P/E is lower now that it has been at any time for the past 10 years.
My conclusion is that energy has made some tremendous gains over the past five years, but the gains in the share price have not caught up to the earnings.
The Energy Information Administration stated in its latest monthly report that West Texas Intermediate Crude (WTI) averaged $72 a barrel in 2007, and is projected to average $110 in 2008. That is a rise of $9 from last month's report.
Here is site to book mark if you are interested in this
are. It's the forecast and analysis web page from the Energy Information Administration:
http://www.eia.doe.gov/oiaf/forecasting.html
World oil consumption is projected to grow 1.2 million barrels per day in 2008. U.S. consumption is expected to decline in 2008 by about 190,000 barrels per day as a result of the economic slow down and high prices. We are consuming less, but world consumption is increasing.
In 2007, world consumption was 85 million barrels of oil per day. In 2008, we will consume 86.2 million barrels per day. At 86.2 million barrels per day, we are near current capacity. Forecasts predict a 100 million barrel
per day demand by 2015. Goldman Sachs analyst, Arjun Murti, came out this week and stated that West Texas Intermediate Crude could see $150-$200 within the
next 2 years. This is the same analyst who predicted $105 oil a couple ofyear ago when oil was under $60.
(Note Arjun Murti's research report came out on May 5th and
created quite a stir among energy and oil analysts. In the report, the Goldman analysts concludes, "We believe the current energy crises may be coming to a
head, as a lack of adequate supply growth is becoming apparent and resulting in needed demand rationing in the OECD areas in particular the United States." In the research report which was sent to Goldman clients,
Murti said, "the possibility of $150-$200 per barrel seems increasingly likely over the next six-24 months, though predicting the ultimate peak in oil prices as well as the remaining duration of the upcycle remains a major
uncertainty." That quote came from an article at the following url:
http://tinyurl.com/53ck8w
)
The weak dollar has also contributed to the rise in oil
prices.
Most of the analytic community is in agreement that the dollar will remain weak against most currencies, as there does not seem to be any end in the near term to our national fiscal issues. Of course, when everyone becomes
bearish on the dollar, there will inevitably be the snap back rally, but will it last? As long as our trade deficit and budget deficits remain high, I expect the dollar to continue to experience overall weakness
vis-a-vis the other major currencies.
The Wall Street Journal reported this week on a study of
satellite photos that revealed the Saudi Arabia Ghawar fields may be slowing production due to their age. There are also reports that the number of drilling rigs has tripled over the last few years, another indication that
they need to boost drilling in order to obtain the same results.
This is significant because Ghawar accounts for 50% of Saudi production, not to mention 7% of global supply.
Note info on this can be found here:http://tinyurl.com/5tmvn2
During the first quarter of 2008, Russia reported an average of 10 million barrels a day production, which represents a 1% decline over the first quarter of 2007. Russia, along with Venezuela, Iran, Iraq and Mexico
are either taxing their crude hoards so much they can't be economically exploited or no company will risk investments there.
I don't think we are running out of oil, but I am sure that easy to retrieve oil is rapidly vanishing. (This is a theory held by the Peak Oil advocates).
Replacing the easily attainable oil will come from deep water drilling and oil sands.
The play on deep water drilling in my opinion is Transocean (ticker: RIG).
The best play on tar sands I think is Suncor Energy (ticker: SU), which happens to be the largest position of T. Boone Pickens. Trust me, it has never paid off for me to bet against this guy!
(Note: Thomas Boone Pickens chairs the hedge fund BP Capital Management with over $4 billion in assets. On April 14th, he predicted that oil would top $125 in the near term, and that prediction was spot on. Read the
article where he made that forecast and the reasoning why at this url:
http://tinyurl.com/5uahes
)
The national oil companies that control 80% of the earth's oil will be pressed to adapt new technologies for extracting oil. The stock play for new technologies of this nature I think will be the service and equipment
sectors in general.
There are four energy subsectors: (1) Refineries; (2) Integrated Oil; (3) Exploration and Production and, (4) Oil Equipment and Services. For brevity's sake, let's eliminate refineries because their profits are
dependent on the crack spread which is the spread between what a refinery spends to acquire a barrel of oil and what it sells the refined products for after the barrel is cracked. This makes refinery earnings very unpredictable and unsuitable for most investors.
Prime examples of Integrated oil stocks are Exxon Mobil and Chevron. Unfortunately, most integrated oil companies have done a poor job of replacing reserves which makes them questionable investments in my view.
Two exceptions are Occidental Petroleum Corporation (ticker: OXY) and ConocoPhillips (ticker: COP). Occidental Petroleum, which refers to itself
as "peanut oil" because of its lack of size compared to Exxon and Chevron, has done an excellent job of increasing reserves. Conoco has done well, in part, due to its purchase of Burlington Resources a few years ago which
was an inexpensive play on natural gas and makes it one of the better integrated oil investments.
A third integrated oil company that has a lot of potential is Petro Bras(PBR). One country after another has nationalized their oil resources,resulting in big losses to companies like Exxon, Chevron and Total S.A.
If you can't beat them, join them. Through ownership of Petro Bras, you will have a piece of the monopoly. Ken Heebner recently said that Petro Bras will be 10 times bigger in 10 years. Brazil has vast natural resouces
and Petro Bras is a major player.
Ken Heebner runs the CMG Focus fund (ticker: CGMFX). In
addition to holding Petro Bras in his fund, Read the top ten holdings of the CMG Focus Fund at this ur
http://tinyurl.com/6d5xxg
Exploration and Production is the next sub-sector I want to
address. This is where companies go out and do the drilling, take the risk and find the oil and gas. Owning these companies during the past year has been very rewarding but will it continue? I think it can because many of these companies sold the gas and oil they produced this year 18 months ago.
Natural gas selling at $11 doesn't help you if you contracted to sell it at $8.50 last year. Exploration and Production stocks could be undervalued because they will come out from under these contracts and be able to
sell gas and oil forward at much higher prices. Overall, I think these stocks are better than refineries and integrated oil, but don't bite off too much.
If they correct 8-9%, get real interested. The top names are Apache Corp. (ticker: APA), Devon Energy (ticker: DVN), Chesapeake Energy (ticker: CHK),XTO Energy (ticker: XTO) and EOG Resources (EOG). This is just a sampling
as there are numerous stocks in this subsector, some of which are potential takeover targets in this market environment. With national oil companies in control of so much oil, the big integrated companies like Exxon and BP
can't replace reserves fast enough by drilling so an alternative is to replacereserves by taking over other companies.
Everyone likes a lay up -- a low risk/high reward potential play right? Because of growing economies in Brazil, Russia, India and China, demand for oil should increase. The low risk/high reward is in oil service, as
the only way you are going to get more oil is to drill more. These companies can be compared to the companies that sold the picks and shovels during the gold rush of the 1800s. Oil service stocks should produce solid
returns under this theory as long as demand remains strong.
Schlumberger (ticker:SLB) is the best of the breed, but sports the highest valuation of the stocks in this sector I follow with a P/E of 23.6. Three other companies in
this sector that have more modest valuations include, Haliburton (ticker:HAL) with a P/E of 12.2, National Oilwell (ticker: NOV) with a P/E 16.8 and Nabors (ticker: NBR) with a P/E of 12.4.
My favorite for deep water drilling is Transocean (ticker: RIG) and a P/E of 10. Transocean reported a better than expected quarter this week, with earnings coming in at $3.80, versus expectations of $3.33. Revenues were
better and costs were lower. It is the best of all worlds. Look for estimates to go up and rising estimates usually move a stock higher.
Transocean also has long term contracts totaling $34.2 billion extending to 2016. Transocean has a very attractive PEG of 0.4. The PEG is the price-to-earnings ratio divided by the growth rate, and the lower the
better. Transocean's long term growth is 40% which is monster growth for a company with a $39 billion dollar market capitalization.
If you want a more diversified approach in the oil servicesector, consider the exchange traded fund, Oil Services HOLDRs which trade under the ticker symbol, OIH. Here is a link to its profile:
http://tinyurl.com/6hvlm7
Another option is the Fidelity Select Energy Service Fund, ticker: FSESX.
Link to its profile here:
http://tinyurl.com/6myjwo
Going forward, I expect an upward trend in energy stock
prices, but not without pull backs along the way. Overall, I believe the sector is fairly valued.
Additionally, I believe that select sectors and certain
individual stocks are undervalued, most notably in the oil and gas drilling and the oil and gas service groups. If the Energy Information Administration is correct that crude oil will average $110 in 2008, then we should expect a pull back from the $120s, which might present an opportunity to buy into that sector for those under-invested.
On the other hand, you may already have more energy exposure than you think as the S&P 500 currently has 14% exposure to energy and many index funds track the
S&P 500.
If you are looking for two good mutual funds that specialize in energy, I like the Vanguard Energy Fund and T. Rowe Price New Era (PRNEX).
Another option is the Energy Select Sector SPDR which
trades under the symbol, XLE and does a good job tracking the energy sector in the S&P 500. If you want something a little more global, try the iShares TR S&P
Global Energy Index fund shares which trade under the symbol, IXC.