Markets & Stocks

How to play the oil patch
Exploration and production companies and oil service firms are in the best position.
February 28, 2003: 11:22 AM EST
By Cybele Weisser, Money Magazine

NEW YORK (Money Magazine) - The price of oil has jumped nearly 80 percent, from $20 a barrel to upwards of $36, and U.S. inventories of crude oil are now at the lowest level since 1975.

What does that mean for companies in the sector? For giants like ExxonMobil, probably not much: Higher prices help some divisions while hurting others, so the impact is mildly positive overall.

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But higher prices almost always encourage the Big Oil companies to spend more on exploration and production, which is a boon to pure-play oil and gas drillers and oil service companies.

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And while oil is in the spotlight now, investors shouldn't forget about the opportunity in natural gas. With North American gas reserves depleting at the rate of 30 percent a year, domestic gas drillers should receive "extensive capital investment," says Standard & Poor's analyst Tina Vital.

Here are the companies that will benefit most.


Analysts expect a big increase in drilling for oil and gas this year, and when demand for maintenance and pump-priming is on the rise, it's almost guaranteed the world's largest oil field service company will benefit.

Who'll benefit
CompanyEarnings growthP/E% off 52-week high
Schlumberger (SLB)17%27.1-39%
Transocean (RIG)-14%21.6-46%
Ocean Energy (OEI)56%11-21%
Nabors (NBR)63%31.6-26%
* Earnings growth and P/E based on estimates for the current year.

As the premier franchise in its industry, Schlumberger has always traded at a premium to the market. But an ill-fated acquisition of technology outfit Sema in 2001, among other bad moves, has sent the stock tumbling from a high of $83 in 2001 to a recent $38.

That has created opportunity, says Mark Baskir of the Strong Energy Fund. Schlumberger has reorganized and refocused its business in the past year. In October it announced CEO D. Euan Baird would step aside for Andrew Gould, the firm's chief operating officer, who has a reputation at the firm for cost cutting.

"The day they announced that change was the day I bought," says Baskir. As with any turnaround, it's hard to predict when the changes will show up in the price. But, in the meantime the $22 billion (market cap) company, which generated $13 billion in revenue in 2002, pays a 2 percent dividend yield.


When spending for oil and gas exploration drops, expensive deepwater projects are often the first to go. Last year, weak capital spending crimped the stocks of firms that specialize in this niche. But $7.2 billion Transocean, the largest pure-play deepwater driller, held up better than the rest, with sales slumping just 5 percent.

In the coming year, high oil prices will support more deepwater drilling. Transocean, which has contracts with nearly all the major oil companies, is expected to see earnings jump 25 percent.

At $21, it trades just 15 percent above the value of its assets, figures Tim Parker, an energy analyst at T. Rowe Price, which recently added to its stake in the firm.

Ocean Energy

Oil and gas exploration is a bit like real estate -- it's all about location. And $3.4 billion Ocean Energy, one of the largest exploration and production (E&P) companies, has the bulk of its business in the so-called Golden Triangle -- the oil-rich underwater locales of the Gulf of Mexico, offshore Western Africa and Brazil.

With the expectation that higher oil prices will give a boost to its revenue, Ocean increased its 2003 capital-spending budget for exploration projects by 30 percent over 2002. This should hike its production growth rates by 12 percent to 14 percent, say analysts, compared with a 5 percent industry average.

Investors also like Ocean's relatively low production costs, kept in check by sharp managers who have also been paring down the company's debt.

Yet the stock isn't expensive. Shares are trading at 4.3 times estimated 2003 cash flow vs. five times for the average midcap E&P company.


No matter what happens with oil prices, one bright spot in the energy world is natural gas. Demand has been rising for this "cleaner" fuel in North America, and with gas reserves at critical lows, drilling is expected to pick up.

The dominant domestic player in gas drilling is $5.4 billion Nabors, whose revenue should soar as demand for its equipment increases, allowing it to raise rates, says Michael Hoover, manager of the Excelsior Energy & Natural Resources fund.

Nabors' revenue took a pounding last year as spending on drilling bottomed out. The stock price plunged. That has the driller's shares trading at 2.6 times book value, which is 24 percent off of their 52-week high.  Top of page

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