(FORTUNE Magazine) – Are oil stocks about to buck the market's malaise and rally? That's the contention of Paine Webber oil analyst Bryan Jacoboski, who just two years ago was known as Bryan the Bear for his downbeat assessment of the industry. Jacoboski is widely considered one of the most prescient energy analysts on Wall Street. His oil price forecasts have been on the money, and he has been early spotting stock market winners like British Petroleum, which he recommended in October 1989 when it was languishing at $55 per ADR. It recently sold for $79. Jacoboski discussed his growing optimism for the industry, and his favorite stocks, with reporter Susan Kuhn.

You have been bullish on oil stocks when the price of crude was coming down. Why? Easy. Most oil companies today can earn more profits with oil at $20 a barrel than they could a decade ago when oil was at $35 a barrel. The industry has gone through tremendous cost cutting and has divested itself of nonperforming assets. Companies have also bought back substantial amounts of shares, so any upswing in earnings will affect stocks much faster.

Do stock prices today reflect their growth potential? No. I am recommending more stocks for purchase today than I ever have. Oils perform very well in a defensive stock market, like the one we've got today. The S&P 500 is down 11.5% this year, but oil stocks have pretty much held their ground.

Why didn't oil stocks respond better to the invasion of Kuwait? We think the stocks reflect investor expectations that the Iraq-Kuwait crisis will be short-lived and that oil prices will fall back to near $20 per barrel. Barring war, I believe that oil will trade in the low $20 range by the end of next year, but that it will average $25 for 1991. That represents a big improvement over pre-invasion prices of $14 to $16 per barrel. Under this scenario, all the stocks we recommend have the potential to increase by 20% next year.

So which companies do you like? My top three are Unocal, Murphy Oil, and Amerada Hess. They all have enormous potential to develop new fields without any new exploratory successes. Investors discount Unocal by up to 15% because it has refining, service station, and chemical operations, which are hurt by higher oil prices. But about 85% of the cash flow comes from upstream activities like exploration, which the company excels at. Pure exploration and production companies trade at ten times cash flow. Unocal trades at half that. Murphy Oil trades at only four times cash flow, the lowest of any of the integrated producers. It has the greatest exploratory potential of any company I follow. It has only 200 million barrels of oil equivalent reserves at present, but it has some incredible positions off the shore of Alaska and in the Gulf of Mexico. A discovery in either would have a huge impact. Amerada Hess is finally upgrading its Virgin Islands oil refinery, which has been notoriously inefficient. It is the largest in the world. Better operations will kick in greater profits.

Do any of these companies have significant exposure to natural gas? They all do. Even though there is still a supply bubble out there, it is diminishing. I think natural gas prices are bound to rise. Unocal, for example, has huge natural gas production potential in the Gulf of Mexico and Thailand. Phillips Petroleum is an especially interesting play on higher gas prices because the company is the largest producer of natural gas liquids, or NGLs, used in chemicals and for home heating. Kuwait is home to a few key naphtha refineries, the main competition for NGLs. If they are damaged, it could take two to four years to repair the facilities, and the demand for NGLs would take off, as would the price. Furthermore, the company's earnings are as strong as ever. Operating earnings will still grow 10% this year to $2.15. In 1991 I expect they will leap 30%. The shares recently traded at $25.75, or only nine times 1991 earnings.

Any other superstars in waiting? British Petroleum has been the best post-invasion performer, but the stock's climb is far from over. BP has the best growth potential of the larger companies, in part because it is targeting new frontier areas like Vietnam and Papua New Guinea (see Corporate Performance). All have promising geological structures, and no significant production exists. It also pays one of the highest dividend yields at 5.4%. Texaco is another promising stock with a high dividend yield, 5.2%. The company has really turned around its operations, but investors have been distracted. First there was the $10 billion damage award for Pennzoil back in November of 1985, then the $3 billion settlement, followed later by the Carl Icahn proxy fight, then $1.7 billion in special dividends, and finally a $500 million stock buyback, which just ended this past summer. All the while, management was reorganizing the company. It used to be more centralized than the Soviet Union. Now it is one of the better operators in the business, but the stock doesn't show it. Even after the buyback, its debt leverage, 38% of total capitalization, is in line with the other majors. I am very comfortable with it.