NEW YORK (CNN/MONEY) -
Oil prices reached a record $42 a barrel on Tuesday, following a weekend terrorist attack in Saudi Arabia. Although the major indexes closed up, the S&P 500 dipped below its 50-day moving average during the day -- which some market watchers interpreted as a signal of a weaker market ahead.
Not surprisingly, energy stocks have been bucking the broad market trend. Most have been strong performers over the past six months (see table below).
Before you invest, however, take a clear-eyed view at the oil price outlook -- the price of crude could easily fall into the $30 to $35 range within the next year or two, which would doubtless hurt energy stocks temporarily.
A higher base
Most oil experts recognize that the era of cheap oil is over, as I discussed in the June issue of Money magazine (see "There's no oil crisis -- yet"). Oil prices over the coming decade will almost certainly be higher, on average, than they have been over the past 10 years.
The underlying reason is simple: Really cheap oil is rapidly being used up. There are plenty of other energy sources available, but they cost at least $10 a barrel more to tap.
Historically, OPEC tried to keep the price of crude in a $22 to $28 target range. But now the organization -- and especially Saudi Arabia, the swing producer -- recognizes that the oil price range needs to be raised above $30.
The current $42 price, however, is probably unsustainable. The last time OPEC kept the price too high for too long, so many other sources of oil production were developed that the price collapsed and stayed down for a decade.
As a result, oil prices are likely to average between $30 and $38 a barrel -- a range that should be comfortable for the economy. On an inflation-adjusted basis, oil traded at nearly $70 a barrel in the early 1980s.
Listen to the market
Stock prices in the sector confirm the likelihood of a pullback in prices.
| Data as of June 1, 2004 | | Source: Thomsom/Baseline |
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Normally, Schlumberger, an oil driller, shows the biggest gains which oil is rising, followed by pure producers, such as Anadarko Petroleum and Apache. The integrated oils, including ExxonMobil and ConocoPhillips, typically move the least. But as the table shows, the integrated oils have done at least as well as the others over the past six months.
There's an explanation. Gasoline prices are so high that the profitability of the integrated oils' refining and marketing operations is even higher than profits from production. That's a classic sign of a temporary squeeze.
Barring a catastrophic terrorist attack, the flow of oil will slowly work its way through the refining and marketing chain. Both gasoline and the crude price should come down somewhat in coming months.
In the stock market, the oil sector is getting giddy. Don't rush to buy now, unless you're planning to hold for at least five years -- and a 10 year horizon is better. Better yet, consider waiting six months or so until you have a chance to buy on a pullback.
My long-term picks remain the same: ExxonMobil and ConocoPhillips are excellent choices for a conservative long-term portfolio. Anadarko is a compelling pick purely as a value play. And for the most aggressive investors, Schlumberger has the highest growth potential.
Michael Sivy is an editor-at-large for MONEY magazine. The Sivy on Stocks column and newsletter is available only to MONEY subscribers and AOL members. Subscribe now and you will also receive access to the Sivy 70 -- our exclusive list of America's Best Stocks -- and coming soon, to Sivy's Guide to Growth. Click here to subscribe to MONEY and to sign-up for the Sivy newsletter.
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