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A slick buy
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November 14, 2001: 6:46 p.m. ET
Oil and gas stocks tumbled on Monday after OPEC failed to stabilize the price of crude. But energy stocks remain key to a balanced portfolio.
Michael Sivy
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NEW YORK (CNN/Money) - Oil prices are down more than a third over the past 12 months. And they're poised to move lower still. OPEC's attempts to stabilize the price of crude seems to be failing because of a lack of support from major non-OPEC producers, such as Russia and Norway, which are resisting production cuts. As a result, major integrated oils are off their highs. And more volatile oil-service companies are getting killed. On Wednesday, Halliburton and Schlumberger both lost more than 6 percent.
Despite the negative near-term outlook for energy stocks, I believe it is crucial to include them in a well-balanced stock portfolio to provide inflation protection. In addition, the oil-service stocks have long-term growth potential that makes them attractive for investors who believe in GARP (growth at a reasonable price). Given all the economic cross-currents -- such as Wednesday's report that retail sales surged a record 7.1 percent in October -- it may be hard to know exactly when to make new purchases of energy stocks. But I think they are certainly buyable here -- even if there's a risk that they briefly go lower before rebounding. And I'd try to pick them up before an economic rebound is clearly under way.
Essentially, there are three arguments for oil and gas stocks. The first is that crude prices are currently weak because of a confluence of short-term trends that have depressed demand. The economy is close to a bottom. The demand for jet fuel is further depressed because of a dropoff in travel resulting from the Sept. 11 attacks and this week's American Airlines crash. Finally, relations between the U.S. and Russia, the second-largest oil exporter, are unusually friendly. Over time, both the economy and air travel will recover -- and Russia's co-operation can never be taken for granted.
The second issue is the long-term outlook for oil production. Demand for oil and gas goes up over time, even if it rises faster at some points than at others. But production can't keep expanding indefinitely. Even leaving aside environmentalist hysteria, responsible analysis shows that existing fields could max out as early as 2004. To sustain or increase production at that point would require higher prices -- perhaps reaching $35 a barrel. Since the oil price is currently below the $22-to-$28 range that OPEC tries to maintain, a substantial increase is likely over the next five to 10 years.
Finally, it's crucial for investors to remember than inflation won't always remain at today's negligible levels. According to the most recent report on producer prices, inflation may actually be negative at the moment. Once the recession ends -- and given the enormous stimulus to the economy from Fed rate cuts and Federal spending -- consumer prices could begin accelerating. And energy stocks remain one of the best inflation hedges.
The question remains, which energy stocks are best to buy now. Exxon Mobil, the largest publicly traded oil stock, is certainly beyond reproach. The company's financials are superb, average earnings growth of 8 percent annually is doable, and the stock yields 2.2 percent. So while Exxon doesn't rate as a growth stock, it's certainly a first-rate inflation hedge. As an alternative, Chevron Texaco looks to me as though its earnings might surprise a bit on the upside thanks to post-merger cost cutting (the acquisition of Texaco was completed last month). Both stocks' earnings will decline next year. At a current $38.70, Exxon trades at 20 times next year's projected results. At $86.60, Chevron looks a little cheaper at a 17 P/E.
Committed growth investors may prefer the leading oil-service companies -- Schlumberger and Halliburton -- even though they're much more volatile (both stocks are down more than 40 percent within the past year). Drilling activity is tremendously sensitive to expectations about future energy demand, so oil-service stocks respond quickly to changes in the price of crude. Halliburton offers growth in the high teens. Currently $21.60, the shares trade at less than 16 times projected 2002 earnings. And if you're really feeling go-go, step up to Schlumberger with 20 percent projected growth. At $46.10, the stock goes for 26 times next year's earnings. 
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