The Odds Favor E&P

10/21/2009 9:44 am EST

Focus: STOCKS

Peter Way

Founder and CIO, Peter Way Associates

Peter F. Way, editor of Block Traders’ Oil & Gold Monitor, says the big money likes energy exploration & production companies, and he finds one name he likes.

The “normal” shape of [oil] prices to come has been a modest decline, reflecting the costs of storage and the financing costs of ownership. “Normal” in the past has taken for granted that there was abundant supply of oil for the world’s needs and technology advances could cover any increased difficulties in its retrieval.

The last few years has adjusted that thinking, leaving few to sneer at the notion of “peak oil” production. Governments controlling large known resources and their pricing are quite alert to the value of scarcity and growing demand from large populations eager to graduate from the sandal, the bicycle, and the oxcart.

The announcement by Exxon Mobil (NYSE: XOM) that it will pay up big time for resources offshore of Africa may be a sign that the press to control existing known reserves is beginning. Bringing previously undeveloped offshore fields into production takes both time and capital, and the costs inevitably will get woven into present and future prices.

Clearly the biggest producer has preferred its own development from scratch to simply buying up onshore or already developed reserves. It remains to be seen whether other integrated majors will follow the same path or start a bidding war for the better independent exploration and production (E&P) companies.

It appears that the recognized E&P targets are already fairly richly priced. Near-term expectations by the block desks and proprietary trading desks of big bulge-bracket brokers do not offer appealing stock price gains for investments at current prices

The greatest concentration of opportunity in energy stocks continues to be in these names, where opportunity lies not in the ownership of reserves, but in the skills involved in their recovery.

FMC Technologies (NYSE: FTI) couples the better parts of energy and electronic technologies. That coupling has marked it among investment professionals as a growth and momentum stock rather than a “value” item.

Spun out of FMC, a machinery company, to take advantage of the allure of high tech and scarce natural resources, the stock has better than doubled since its late-2008 low. Still, it performs best when the forecasts show slightly more down side than up side, as they do now.

The odds for gains here approach three to one, while the largest downside experiences following forecasts like the present are less than -7%. The largest up side moves have been three times the biggest down side exposures, and twice what is now being forecast.

As a result, when evaluated in an odds-weighted reward-to-risk contest, FTI ranks better than 93% of the rest of widely-held and actively-traded stocks and ETFs. We recommend it as a buy here. (It traded below $56.50 Tuesday—Editor.)

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