NEW YORK (CNN/Money) -
It's been a good nine weeks for investors. Investors who hold oil services and driller stocks that is. Because while the broader stock market has been struggling and last-year's rally leader, the tech sector, has been sliding, oil has been heating up.
And while crude prices are likely to remain high for some time, oil stocks may be getting too hot for most investors to handle, analysts said.
Fears of OPEC supply cuts, growing global demand and continued worries about potential terrorist attacks have driven the average 2004 price of crude oil up to about $35 a barrel, the highest in more than two decades. On Wednesday and again on Friday, NYMEX light crude oil futures peaked above $38 a barrel, a level not seen since just before the start of the Iraq war in March 2003.
Year-to-date, the S&P 500 is up less than 1 percent as of Thursday's close. But the Philadelphia Oil Services (Charts) index is up 15 percent.
The Oil Services Index tracks 15 different companies in the oil and gas equipment and services and oil and gas drillers sectors, including Schlumberger (SLB: Research, Estimates), Transocean (RIG: Research, Estimates) and Baker Hughes (BHI: Research, Estimates).
Among the S&P sectors, oil and gas equipment services is the fifth best performing sector year-to-date, up more than 13 percent. The drillers are No. 10, up almost 12 percent.
Too much of a good thing?
Although the stock prices of oil companies aren't likely to tank any time soon, some analysts are concerned that the upside too may be limited.
"Higher demand in China, OPEC's actions to constrain supply, the falling dollar, the notion of potential supply disruption due to activities in Iraq, concerns about motor gasoline -- all of this has contributed to investor perception that oil prices are going to stay high and that companies in the sector will benefit," said Brad Handler, an oilfield services analyst at Blaylock & Partners. "So investors have bid up a number of stocks. With valuations where they are, we think the sector as a whole has gotten pricey in the short-term."
It's a concern echoed by other analysts as well.
"Oil services stocks, in particular, are well ahead of the group's fundamentals," said Wesley A. Maat, senior oil services analyst at Fulcrum Global Partners. "They are very expensive right now relative to earnings. We think they are fully valued or even overvalued as a group."
Short-term, the analysts think the sector could be due for a mild pullback.
However, Magnus M. Fyhr, a managing director at Jefferies & Co. who covers the sector, thinks that investors could use this kind of pullback as an opportunity to get into some of the oil stocks. His sense is that the driller stocks could correct in the seasonally weak second quarter by between 5 percent and 10 percent. However, in the second half of 2004, his forecast is for the group to rebound and add another 35 percent off those lows through the end of the year.
How a possible slide in oil prices would impact the stock prices is also up for debate.
"If oil prices fall due to increased supply, that would be bullish for the oil sector," Fyhr said. "But if oil prices fall because of lack of demand, you'll see the stocks pull back as well."
Crude oil prices likely to remain high
This may be a moot point in the near term, however. Although analysts believe crude prices are likely to scale back modestly in the next three to six months, the factors that will support higher prices throughout the year are likely to remain in place. As last week's series of coordinated bombings in Madrid and the ongoing Iraq war make clear, the threat of global terrorism and oil supply disruption remains.
And demand is not likely to drop. In early March, the International Energy Agency raised its 2004 forecast on oil demand growth for the fifth consecutive month. Concerns about the rising oil prices and how that might impact the recently slower economic recovery has weighed on the broader stock market in the last few weeks.
OPEC -- the Organization of Petroleum Exporting Countries -- has expressed concern about the impact of the higher prices on the global economy. But the cartel is still planning to go ahead with its previously announced plans to cut production to 23.5 million barrels per day from 24.5 million, as of April 1.
-- Analysts quoted in this story do not own shares of the stocks that they discussed, nor do their firms have investment banking ties to the stocks.
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