A "Wave" of Production Profits

08/05/2005 12:00 am EST


Tobin Smith

Founder and Chief Research Analyst, Transformity Research LLC

Backed by his ChangeWave Alliance of thousands of individuals around the world in various industries, Tobin Smith focuses on finding emerging trends, and isolating the best stocks to play those "waves." This strategy puts him early into energy, where he still sees opportunity.

"The next big move in energy stocks is coming from the analysts and the oil companies that are now finally moving up their price-per-barrel forecasts to reflect the reality of the secular supply/demand imbalances in the world’s energy supplies. If you take the futures prices out to 2011, for instance, an oil trader on the floor of the New York Mercantile Exchange will tell you prices will be $54 at that time. Yet, if you take the European oil sector equity valuations, you come up with a $30-per-barrel price of Brent crude, which we consider ridiculous.

"Even more ridiculous are American-based exploration and production valuations. Taking the values of reserves per share, we are pricing exploration and production companies with $20–$25 oil valuations. S omething we can count on for sure in the energy sector is $40 oil, then $50 oil being priced into energy exploration and royalty trusts. Especially in light of the continued escalation of world oil and gas consumption—considering producible reserve declines and continued production declines in most areas of the world.

"It is important that you sell the large integrated companies and diversify into other areas such as exploration and production plays, which are priced as if oil will sell for $20–$25 instead of $40–$50. Most of the easy-to-find and easy-to-recover oil wells have basically been found. We are consuming 84 million barrels a day, heading to 88 million by the end of the decade. But reserves are falling 2%–3% a year. Within the exploration and production sector, our favorites are Cimarex Energy (XEC NYSE), Gasco Energy (GSX ASE), Patterson-UTI Energy (PTEN NASDAQ) and XTO Energy (XTO NYSE).

"Combine the dwindling natural gas reserves in the US with Canada’s need to use more of its natural gas to extract oil from its tar sands and whadaya get? The trend is for higher energy costs until we see a super spike to $80 or more, or until we start bringing in about ten trillion cubic feet of natural gas. Refineries are running at full capacity and this will prevail all summer due to end-market demand. Throw in a hotter-than-average summer, a few hurricanes, and you understand what I’m talkin’ about. The energy consumption imbalance is as strong as ever. If you sold energy stocks in the April/May correction, you were listening to the wrong advice."

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