3 Energy Patch Bargains

07/05/2011 12:30 pm EST

Focus: STOCKS

Peter Way

Founder and CIO, Peter Way Associates

Crude may be lower, and the price at the pump easier on the wallet, but that doesn't mean there aren't some good bargains in the oil patch, says Peter Way of Block Traders' Oil & Gold Monitor.

"It's usually safer to count on shortage than on oversupply," is a maxim proposed over 50 years ago to a green security analyst just starting out, covering metals stocks.

But even then, one needed to know where investors were coming from, since changing expectations is what produces the payoff—a change in the investment’s price. If shortage was already what had been expected, then not much stock-price change was likely when the tight times arrived.

If instead, markets were already positioned for tighter supply times, and it became less likely to arrive soon, then the probable price direction is down. This is what we are seeing now in crude oil, at least for the near future.

The “Arab Spring” of independence set up the shortage concerns. First in Tunisia, then in Egypt and Libya, and spreading further to other Middle East countries with oil production that might be disrupted.

Markets had been at over $100 a barrel. But now the odds for disruption may be shrinking.

Besides things settling down in energy-critical places, the Saudis have made it well known for a while that they are increasing production, despite the inclinations of others in OPEC.

Does this foretell a longer-term slide in crude prices back towards $60? Or lower? [For the record, several Saudi officials have pinpointed their target price at around $70, a level that would conveniently force many competitors (like the Canadian oil-sands firms) to the sidelines—Editor.]

The biggest advantage of a very sophisticated global market for energy is that expectations are not kept hidden beyond the near future. In fact, the NYMEX market in West Texas Intermediate (WTI) Crude specification provides quotes out to December 2019. We regularly examine hedgers’ actions out to the end of 2015.

What we are seeing now is a marked reduction in concerns to the upside, but only in the “front” and “next” months. Each other contract month expiring between now and the end of 2013 sees price insurance being bought to cover the possibility of at least $125 a barrel at the upper end.

On the downside, settlement prices are typically at the bottom end of the implied forecast range, or even below it in many cases. Your tank is likely to get very dry, waiting for $60 crude.

That doesn’t mean that the whole settlement curve won't continue to shift, but so far the move down has not meaningfully brought the hedgers’ forecasts lower with it. We just view the current weakness in crude
price to be a temporary interruption to a coming norm in the low triple digits.

The present weakness in crude pricing has induced some attractive price circumstances in oil patch stocks.

Hess Oil (HES), a fully integrated US-based producer, meets our investment minimum to be a buy—a risk-balanced prospective return of 5% in the three months. Its price, relative to expectations, has been this low less than 1% of the days in the past four-plus years.

Several independents are also attractively priced. When hedgers have sought in the past to protect themselves against unwanted price moves in the way they are now, some highly desirable price moves subsequently evolved.

Pioneer Natural Resources (PXD), now a $90 stock, was seen as this cheap at the market’s recent bottom in March 2009. It turned up from $12 then and never looked back, achieving prices over $100.

Its sell target now is 18%. Look for a new something better when you get there.

Carrizo Oil & Gas (CRZO) has a long history of successful market-maker and prop-desk forecasts. In some four years, it has been viewed by them as this attractive more than 175 times, and subsequent to each spent nearly 80% of the time in higher price territory. Gains averaged +13% by closeout, but frequently got
as much as +22% above cost.

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