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The case for buying oil stocks

Investor Daily: Even with gas prices in free fall and the global economy sputtering, now may be the time to bulk up on oil shares (if you dare).

By Brian O'Keefe, senior editor
Last Updated: November 21, 2008: 7:26 AM ET

NEW YORK (Fortune) -- Last week, the Paris-based International Energy Agency released its World Energy Outlook 2008 - a 578-page book full of future supply, demand, and price estimates which this year also included an eagerly-awaited study of 800 of the world's largest oil fields.

Here's the executive summary: Buy oil stocks.

Considering that the price of oil has plummeted from $147 a barrel in early July to below $50 and that the global economic slowdown is putting a major damper on demand, that might not seem like such a good idea. But as the IEA study makes clear, the long-term supply and demand picture for oil continues to favor higher prices. Maybe much higher.

The report estimates that energy demand will grow 1.6% a year on average through 2030, for a total increase of 45%. To meet that demand, daily oil production will need to rise from today's level of 85 million barrels to 106 million barrels. The study found high and rising depletion rates at existing oil fields that will make it increasingly hard for new supplies to keep pace. So, the IEA says, the world needs to invest some $26 trillion over the next couple of decades in infrastructure and exploration.

"Given what we know about the decline rates, just to stay flat [in global oil production] we'd have to add the equivalent of four Saudi Arabias between now and 2030," said Matt Simmons, chairman of Houston energy investment bank Simmons & Co. International and author of Twilight in the Desert, the 2005 book that argues that even oil-rich Saudi Arabia's petroleum production might have peaked. "It's a very, very scary study. It's hard to argue with the data and it's ghastly what the data says."

Over the next seven years, the IEA predicts that the price of oil will average $100 a barrel, and rise to more than $110 by 2030. "The era of cheap oil is over," Nobuo Tanaka, the IEA executive director, told reporters at a press conference in London.

If Tanaka is right, the vicious sell-off in the equity markets over the past couple of months makes this a historically good entry point for investors looking to grab oil-industry bargains.

One stock to look at is National Oilwell Varco (NOV, Fortune 500), which has fallen 80% from its 52-week high. The Houston company sells drilling rig equipment, provides tools, and offers supply chain services to oil exploration companies around the world. NOV estimates that more than 90% of the mobile offshore rigs and more than half of onshore rigs built in the past two decades use components it manufactured.

If you can get past National Oilwell Varco's somewhat goofy name, the stock is extremely attractive at the current price. Not only does it trade at less than four times its earnings for the past twelve months, but NOV's market cap of $7.5 billion is less than its $12.3 billion in sales over the past four quarters - giving it an inviting price-to-sales ratio of 0.6. It's also on solid financial ground. The $1.76 billion in cash on its books exceeds its $1.5 billion in long-term debt.

Unlike its stock, the company's business has continued to thrive this fall. In the third quarter, National Oilwell Varco's sales increased 40% over the previous year. New orders worth $2.4 billion brought its total order backlog to a record $11.8 billion. Even if a few contracts get canceled, the company has pretty solid earnings prospects for the next couple of years.

If the IEA's vision of the future is close to accurate, NOV should be a big winner over the long run.

Looking for guidance in navigating these choppy markets? Let us know what topics you'd like us to cover and we'll try to address your questions in an upcoming Investor Daily. Please note: Fortune cannot give personalized advice on specific investments in your portfolio. To top of page

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