Prospects for the oil market are looking good, according to industry analysts. Although high prices have caused consumers to use less fuel, the market is continuing to rise thanks to the growing demand from emerging markets like China, the world’s second-largest consumer of energy. Oil prices have gained more than 30 percent this year, breaking $60 a barrel during trading last Tuesday in New York. According to an Energy Department report issued May 6th, US crude supplies rose 605, 000 barrels to $375.3 million, the highest it’s been since 1990.
The oil market is certainly ahead of itself, despite a continual decline in total fuel-demand. Meanwhile, major independent oil companies have halted exploration budgets and cut back on planned capital expenditures, waiting for a rebound. The latest U.S. employment data is suggesting the economic slump is bottoming out, all of which means that if and when demand for oil rebounds, a surge in supply will ensue.
The growing consensus among industry analysts is that we can anticipate seeing stocks propel even higher. But, “The question is not if, but how fast? How much?” says Oppenheimer analyst Fadel Gheit. Given the current economic conditions, it may seem counterintuitive to go bullish on oil prices. But investors are betting that as the economy gets better, the commodity market for oil is a lucrative place to be.
Mina Kimes, of Fortune magazine, gives her two cents on which companies to bet on:
One tried-and-true approach to betting on oil is to buy the biggest, most stable company in the sector. That, of course, is Exxon Mobil (XOM, Fortune 500), which, with $477 billion in revenues, is by far the largest of the supermajors and has the best return on equity. But many oil investors aren’t wild about the stock at its current price. While Exxon is the largest holding in T. Rowe Price’s $2.9 billion commodity-focused New Era Fund, manager Charles Ober says the stock, though ultrasafe, isn’t worth its premium over its peers. Exxon has a P/E ratio of 8, the highest of the majors. Plus, Exxon’s very size and stability mean that it probably won’t rise as much as its smaller rivals if there’s a strong move up in crude. “Right now, I’d rather have something that’s more levered to the price of oil,” says Ober.
Where should you look beyond Exxon? With future capacity in short supply, the best way to pick winners, analysts say, is to focus on the few companies that are positioned to sharply increase production. And among the oil giants, the company with the brightest outlook is Chevron (CVX, Fortune 500). Barclays estimates that Chevron will increase production by 2.7% annually through 2012, the best rate among the super majors. “Right now, Chevron has more resource opportunity than they’ve had in a long time,” says J.P. Morgan analyst Michael LaMotte, who expects the company to work deals to get access to new reserves in countries like Iraq and Brazil. With a P/E of 6, Chevron is also cheaper than Exxon, and its dividend yield of 3.8% is nearly twice that of its bigger rival.
A pair of mid-majors also offer robust growth prospects. According to Barclays, Hess (HES, Fortune 500) will increase its production capacity by an average of 2.4% a year through 2012. But J.P. Morgan’s LaMotte believes the company’s holdings in Brazil and West Africa give it the potential to far surpass that estimate. “When you look at exploration upside, Hess has considerably more than any other company,” he says. Marathon Oil (MRO, Fortune 500), which Barclays expects to boost production by a robust 4.3% this year, is a particular favorite of Ed Maran, the manager of the $2.1 billion Thornburg Value Fund. “It’s trading far too cheap relative to the value of its assets,” says Maran.
But perhaps the most impressive growth story in the oil world belongs to Petróleo Brasileiro (PBR), or Petrobras, the giant Brazilian oil company based in Rio de Janeiro. Over the past two years the company has announced three deepwater discoveries that are potential mega-fields. While they’ll take years to develop, they have vast potential. “If you look across all the companies you can buy as an oil investor, there’s only a handful of companies that can grow organically, and we like Petrobras the most,” says Cheng of Barclays. He also points out that while new investors have flocked to the company’s common stock, they have largely ignored its preferred shares, which currently trade at a significant discount. If you’re going to play the oil rebound, you might as well start from the lowest point possible.