Next week it's oil, oil and more oil earnings. To know where the industry is going, forget profits and look at capital spending

07/24/2009 5:56 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Exxon Mobile (XOM). Chevron (CVX). Royal Dutch Shell (RDS.A). BP (BP). ConocoPhillips (COP). Noble Energy (NBL) Apache (APA). Petro-Canada (PCZ). All these production companies report quarterly earnings next week.

Add in drilling equipment and oil service companies such as Smith International (SII), Oil States International (OIS) and National Oilwell Varco (NOV) and you've got quite a week for oil.

Move over technology, it's time oil stocks get their fifteen minutes of fame. But what's most important next week isn't the topline earnings per share numbers that will grab the headlines. If you really want to see where the oil market and oil stocks are headed, concentrate on what these companies say about their capital spending plans for the rest of the year. That will tell you whether oil company CEOs think we're seeing a real, sustainable economic recovery that will keep oil prices climbing or a temporary gusher that will dry up in a few months.

Earnings, after all, are a backward looking indicator. They tell you where the company is coming from and how good the last quarter has been in comparison to that prior quarter or the quarter a year ago. If investors are lucky, comany management will make some projections about the next quarter and maybe the rest of the year.

But if you want a truly forward looking measure--and one with real dollars behind it--listen for what companies are saying about their plans to spend millions or billions on drilling new wells or looking for new oil fields. Over the last year, when oil prices collapsed from $140 a barrel to below $40, oil companies have been cutting capital budgets or at best holding them steady. Now that oil is pushing $70 a barrel again, if oil companies believe this rally in prices is for real, that is based on a global recovery in the demand for oil because economic activity is picking up, we should see capital budgets at least holding firm and may be even expanding a little.

Don't look for too much, though. Oil companies are slow moving, by and large, and conservative. They're not about to increase spending by 20% on some 3-month rally in oil prices.

Different oil companies hav different agendas that you need to understand in order to read their capital spending plans as indicators of the state of the oil recovery. ExxonMobil held its budget firm and isnt likely to show much change. Similarly, Chevron has a list of on-going capital projects as long as your arm and isn't looking to add new work. On the other hand, Royal Dutch Shell and BP, the two majors with the most catching up to do after a long period of lagging the industry on new finds, are likely to be the most aggressive. If they aren't yet raising capital budgets, it's a negative. I'd expect Apache, the master at buying older fields that their owners consider finished and increasing production, will be a tough read. The company might be investing because companies such as BP and Royal Dutch are selling older fields to raise cash to invest in finding new reserves. Or Apache could be sitting the moment out, figuring that prices being asked for older fields are too high with oil at $70 a barrel and that they'll cost less in a few months. In this case you'll have to pay close attention to how the company explains its plans as well as the direction of those plans.

Oil drilling service and equipment companies are lagging indicators in this sector. They won't see an increase in orders until months after the oil companies have set their capital budgets. When these companies report, pay close attention to what they say about order cancellations. A slowdown in customers cancelling projects will be a sign that oil producers think there's something to this oil rally thing.

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