The sector looks ready to participate in the market rally, and here are some best bets to watch, writes Michael Brush of MSN Money.

One sector that has been left out of the market run-up is energy stocks.

Oil prices are relatively high, at about $102 per barrel for Brent crude. Typically, energy stocks trade in lockstep with oil prices. And for the first time since 1965, there's a huge divergence between energy stocks and oil, with energy stock valuations sinking sharply even as oil prices have risen over the past two years.

Oil is getting harder and more expensive to find and produce. Most of the major recent discoveries, for example, are in deepwater. The new source of oil from shale rock in the US adds to supply, but it's not enough to be a game changer, given the steady increase in global demand.

Another factor at work here is the Organization of Petroleum Exporting Countries (OPEC), which openly talks about $100 oil as its take on fair value for crude. Here are three other factors that suggest energy stocks should move higher from here.

  • Insiders are buying.
  • The price of natural gas in the US has rebounded. And it is likely to keep rising.
  • President Barack Obama suddenly seems more energy-friendly than a lot of people assumed.

Here's a quick tour of some energy stocks that look the most attractive, according to fund managers in the space.

Apache (APA) and Devon (DVN) are US-based producers with good, diversified portfolios of oil and gas reserves. They both look very cheap, as measured by enterprise value (market capitalization plus net debt) to proven reserves. By this measure, Apache trades at about $16 per barrel and Devon is at about $10 per barrel.

Royal Dutch Shell (RDS-B) also looks cheap, in part because of unfounded concerns that the company is so large it will have trouble replacing reserves, says Tom Karsten of Karsten Advisors. He doesn't think that will be an issue. Meanwhile, you get paid a 5% annual dividend yield while you wait for Shell to prove it.

Brad Evans, who manages the Heartland Value Plus Fund (HRVIX), favors US natural gas plays like Ultra Petroleum (UPL), because he says the price of natural gas in the US will continue to go up from here, for two reasons:

  • Industrial demand in the US from steel, fertilizer, chemical plants, and energy refineries will continue to increase.
  • Supply gains will be limited because so many companies that rushed into natural gas production shifted back to oil production over the past few years when natural gas prices fell.

Weatherford International (WFT) provides equipment, such as submersible pumps, that helps energy producers squeeze more out of old wells. The stock has been held back by accounting problems related to the timing of tax expenses and possible violations of US rules that prohibit bribes for business abroad.

John Groton, at Thrivent Financial for Lutherans, says that the first issue has been resolved, and that the company has reserved cash to pay possible fines related to the second issue. The stock looks cheap, he says, trading at just above book value, compared with a historical average of 1.8 times book value.

To see the other eight energy stocks on Michael's list, please read the rest of the article at MSN Money.

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