Don't Slip Playing On Oil

Dec. 20, 2004 -- Crude oil prices, which recently corrected from a peak of nearly $56 per barrel in late October, have remained at lofty levels for the past two years, generating sizzling gains for oil and energy-related stocks. The S&P energy sector, which makes up 7.1% of the S&P 500-stock index, has risen about 25.8% this year through December 10, far outperforming other sectors in the S&P 500, which was up 6.5%.

How should a prudent investor participate in this oily abundance? With strong gains this year, many energy stocks appear fully valued, but investors must be selective in looking for attractively valued stocks, said Tina Vital, integrated oil equity analyst at Standard & Poor's. Vital likes large international integrated oil companies like ChevronTexaco Corp. (CVX), Total (TOT), Exxon Mobil (XOM), and ENI (E). "These companies are diversified, with a nice balance between upstream and downstream businesses," she said. "They tend to be insulated from both commodity-price and economic risks. Even if global oil demand and oil prices decline next year, these companies should still provide strong earnings growth."

Vital is also optimistic about oil and gas drilling and services firms. With spare oil production capacity low and energy demand worldwide increasing, Vital expects global energy spending will remain high, in the range of $150 to $200 billion annually over the next 25 years. She further expects spending will shift from the mature basins of North America to lower cost, undeveloped regions in Europe, Africa, the Middle East, and Asia/Pacific.

Within the S&P 500's energy subsectors, oil and gas refining, marketing, and transportation skyrocketed 55.1% year-to-date through Dec. 10, 2004, while oil and gas exploration and production (E&P) surged 34.7%. However, while global upstream spending has remained high, spending growth was constrained in 2003, as oil companies were wary about a downturn in oil prices and limited worldwide drilling prospects.

Oil, which traded at $20 throughout most of the 1990s, is likely to trade at between $35 to $45 for the near term, with an occasional spike to $50, said Brian Hicks, co-manager of US Global Investors Global Resources Fund (PSPFX). "At the current low $40s price, oil companies generate big profits and have the incentive to develop new properties," Hicks said. "Even at $30, they're still in good shape." Using supply and demand projections from Global Insight, S&P's Vital forecasts a $39 WTI crude oil price by the end of 2005, and average prices of near $42 in 2005, $36 in 2006, and the mid-$30s in 2007. By comparison, WTI crude oil averaged $31 in 2002, and $26 in 2003.

Along with oil prices, energy stocks have been affected by Wall Street's changing view of the sector. "In the 1990s, investors largely ignored energy stocks, despite their strong fundamentals, cash flow, and earnings growth favoring such areas as information technology, consumer discretionary, and industrials," said J. C. Waller, manager of the ICON Energy Fund (ICENX). "The market didn't reward energy equities with high multiples, leaving the sector underappreciated. Now some investors appear to have better recognized its many strengths."

Quite a few mutual funds have high energy exposure, either as a pure energy play, or as a major part of a natural resources portfolio. The following table shows the five best performing energy funds for the one-year period through November, when the average energy fund gained 49.9%, versus a 12.9% showing for the S&P 500.

The Five Best Performing Energy Funds for the One-Year Period through 11/30/04

Fund

Returns (%)

ProFunds: Energy Ultrasector/Iv (ENPIX)

+82.2%

State Street Research: Global Resources Fd/A (SSGRX)

+71.9%

ICON Energy (ICENX)

+62.8%

UMB Scout Energy Fund (UMBEX)

+59.2%

Fidelity Select Natural Resources (FNARX)

+41.1%

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