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Dark days for oil
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November 19, 2001: 6:34 p.m. ET
With crude prices at two-year lows, oil stocks are hurting.
By Paul R. La Monica
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NEW YORK (CNN/Money) - Sunday's $15.2 billion proposed marriage of Phillips Petroleum and Conoco could be the start of another round of massive consolidation in the energy sector. And that might be just what some of the companies in the beleaguered oil sector need for stock prices to start moving higher.
Low oil prices may be great news for gas-guzzling consumers but they are a curse for the energy companies. With the price of crude oil hovering around $18 a barrel, its lowest level in more than two years, the AMEX Oil Index has sunk 12.8 percent in the past two months.
It is now clear that oil companies will have to take drastic action to make up for lower prices. Cutting back on exploration and production is one way to achieve that. Merging is another. Phillips and Conoco, for example, bragged that the merger would enable them to save $750 million annually. "This deal is going to prompt further consolidation. The continuing volatility in petroleum prices makes it imperative for these companies to find ways to reduce costs," says George Gaspar, an oil analyst for Robert W. Baird in Milwaukee.
More mergers?
Even though Phillips agreed to pay no premium for Conoco (the transaction was billed as a merger of equals), the stocks of both Phillips (P: up $1.38 to $54.73, Research, Estimates) and Conoco (COC: up $0.92 to $26.90, Research, Estimates) rose slightly on the news of the deal. Investors in the acquired company typically sulk when no premium is attached to a merger but it seems that the mere mention of cost savings was enough to excite Wall Street. "A decent move in a tough fundamental environment gets rewarded. These companies are doing the right thing," says Dan Pickering, director of research for Simmons & Co, a Houston-based boutique investment bank that focuses on the energy sector.
With that in mind, Pickering says other mid-sized integrated oil companies like Amerada Hess, Kerr-McGee, Marathon Group, and Unocal could wind up seeking out merger of equal partners or get scooped up by even larger oil companies. Gaspar also thinks Kerr-McGee, Marathon and Unocal could sell out, and adds Apache, Burlington Resources, EOG and Occidental Petroleum to his list of takeover targets.
What's more, Gaspar thinks that these smaller companies are more likely to sell out to larger rivals for a premium. Gaspar says that Unocal in particular is a prime target to be acquired. For one, the company holds a patent on the additives used in so-called "clean gas". Unocal also recently announced a significant discovery in an oil field off the coast of Corpus Christi, Texas. "I'm just absolutely floored that Unocal is still around as an independent company," Gaspar says.
Bad memories
The current slide in oil prices is starting to remind some industry observers of the nightmarish year of 1998 when prices slid to $10 a barrel. That year's precipitous decline in oil prices brought about several mergers in the energy sector, including two colossal deals: BP's purchase of Amoco and Exxon's acquisition of Mobil.
Pickering says that it is unlikely prices will fall that low this time around but he adds that it wouldn't be a surprise if prices slumped to the $14 to $16 a barrel range, a level that he says would "create a fair amount of pain" for the oil companies. Hence, the sudden urge to merge.
Still, investors should tread cautiously in the sector. There is an excess supply of oil and it does not appear that Russia, the world's second largest oil producer, is going to cut production as much as the Organization of Petroleum Exporting Countries (OPEC) would like. Russia is not a member of OPEC. Demand for oil has also been relatively weak due to the aftermath of the terrorist attacks on September 11 and an unusually warm autumn throughout the United States.
Pickering says investors would be wise to stick to companies that have more exposure to the natural gas portion of the energy market, an area where prices have not fallen as far as crude oil. In the exploration and production area, he lists Apache as a favorite and adds that Nabors Industries (NBR: up $1.30 to $30.75, Research, Estimates) and Noble Drilling (NE: up $1.49 to $28.26, Research, Estimates) are two services companies that should benefit from their natural gas exposure as well.
Until there is concrete evidence of a bottoming out in oil prices, investors should realize that there is likely to be more downside for the group in the months ahead. Those with a larger appetite for risk might want to consider some of the takeover candidates we mentioned. But don't expect the overall energy sector to gush anytime soon. 
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