If You Think Oil Will Bounce

07/30/2008 12:00 am EST

Focus: STOCKS

Peter Way

Founder and CIO, Peter Way Associates

Peter F. Way, editor of Block Traders’ Oil & Gold Monitor, recommends two energy stocks that look better now that crude has fallen.

Our [account] of the crude oil market’s own forecasts of its future has turned out to be near spot-on. The flat “curve” of settlement prices across monthly [futures] expirations between now and the end of 2010 has dropped across the board by $10.

[A recent] September futures forecast was [for crude oil] from $110 to $129 [a barrel], with the settle price at the top of that range. The calendar year’s remaining expiration months show lows possible down to $100, and no highs above the present settle curve.

That doesn’t leave much room for energy stock price enthusiasms. In fact, most oil stock indexes are at their lows for the year. But the pros’ forecasts show near-record upside probabilities.

This is the usual paradox. When investors have reacted most extremely and driven prices down, the market makers are alert to the up side. If they sense their clients have not turned negative on the depressed issues, then the widened upside creates buying opportunities.

Like now. Out of two dozen big international integrated oils, two-thirds of them offer odds-on return prospects above our minimum investment hurdle of +5% gain in the next three months. Back in mid-May only three did.

In May [we said] that the nature of the crude oil market was changing, after reaching $125 a barrel. Stock prices of the major producers started down almost immediately and have yet to stage a convincing upturn, even after a [significant] slide.

But the investment appeal is present even now, and given all the supply-side uncertainties possible without warning in the equation, it may not be too early to anticipate the strength indicated for crude prices after the turn of the year. Some nibbling here is warranted, and Apache (NYSE: APA) appears to be the most attractive among the majors. (It closed below $108 Tuesday—Editor.)

Our case for the attractiveness of the independent exploration & production companies has been and remains the decade-long demonstrated inability of the majors to find enough new resources to keep their ratios of proven reserves to production from declining. Acquisitions will be the answer; E&P companies will be the targets.

That path was recently renewed by Royal Dutch in an acquisition of a Canadian E&P. More are likely to be forthcoming, so they deserve a major allocation of your portfolio’s assets. The E&P stocks have also reflected the decline in crude prices, so buying opportunities now are even larger and more numerous than among the majors.

Less impacted by crude prices are the oilfield services companies. The most promising there is Superior Energy Services (NYSE: SPN). (It closed below $48 Tuesday—Editor.)

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