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NEW YORK (CNN/Money) -
The first six weeks of 2005 are looking awfully similar to 2004 for investors -- oil stocks are on fire and just about everything else has struggled.
The S&P Energy sector index has jumped 11 percent so far this year, compared to a slight loss for the S&P 500.
Natural resources mutual funds are by far the best performing fund category, up 7 percent year-to-date, according to Morningstar. And the top stock in the Dow so far this year? That would be Exxon Mobil (Research).
Oil prices are hovering near $48 a barrel and several energy industry watchers think high prices should lead to sizable earnings gains for major oil companies in the near term.
To that end, analysts expect first-quarter earnings for companies in the S&P Energy sector to jump 26 percent from a year ago, according to Thomson/First Call.
So it's no secret that all the ingredients are in place for another strong quarter for companies dependent on Texas Tea. The question is, how much longer can the group rally?
A peak for oil?
Some analysts think oil stocks have little room left to run since it's hard to imagine a scenario where oil prices can head substantially higher. Last year, there was a perfect storm to fuel a surge in oil prices, culminating with a record high of above $55 a barrel in October.
More violence by insurgents in Iraq, a series of hurricanes in the Gulf of Mexico, concerns about labor disruptions in Venezuela, Nigeria and Norway, as well as the collapse of Russian oil company Yukos, all helped to generate worries about oil supply. But these fears may have artificially inflated the price of oil.
"We're sort of in an oil price bubble," said Gene Gillespie, an analyst with Howard Weil, a boutique research firm focusing on the energy sector.
And if oil prices start to come down, so could the prices of oil stocks. "I think that oil prices have reached the upper end of their range for the year and should be heading lower for remainder of the year. Sentiment for oil stocks tends to follow commodity prices," said Lysle Brinker, an analyst with John S. Herold, another energy research firm.
Even if prices slip slightly, investors could wind up being disappointed by energy company earnings as the year progresses.
"Earnings estimates are factoring in generous prices and in the second half of the year comparisons are going to get difficult," said Gillespie. As such, analysts are currently forecasting just 1 percent profit growth for the energy sector in the second quarter and a 4 percent year-over-year decline in the third quarter.
Big oil companies crushed analysts' expectations in the third and fourth quarters of 2004. Exxon Mobil beat estimates by 23 cents a share, for example. Brinker at John S. Herold said investors shouldn't get used to that type of performance though.
"Companies won't be beating estimates by as much. The fourth quarter was probably the best that we'll see for a while," Brinker said.
Still some buys ...
Still, some say that investors aren't banking on another year of huge earnings gains from oil companies. And as long as crude prices don't collapse, this thinking goes, there are still opportunities out there.
"Of course I'm worried about oil prices. But sustainability is what investors are looking for. If oil were to stabilize in the low $40s and stay there, valuations could move up," said Ted Parrish, co-manager of the Henssler Equity fund.
Parrish owns shares of Exxon Mobil and BP (Research) in the fund and says he's comfortable with those stocks because of the firms' international exposure and immense capital resources. "These are the best and safest way to play the energy markets," he said.
Dan Pickering, an independent analyst, agreed that the price of oil isn't likely to return to last fall's levels. But he doesn't think oil needs to climb back above $50 to justify higher prices for oil stocks.
"Oil prices will remain strong but are unlikely to make a huge surge," Pickering said. "But stocks are not going to be driven by upside earnings surprises this year. 2005 will be about sustainability of commodity prices, earnings levels and cash flows."
With that in mind, Pickering said his top picks are integrated oil giant Royal Dutch Petroleum (Research), oil and gas producer XTO Energy (Research) and oil services firm Halliburton (Research). The expected spin-off of Halliburton's controversial government contractor KBR will be a positive for the stock, he added.
And J.C. Waller, manager of the Icon Energy fund, said he still sees some bargains in the sector despite last year's big run. He cites transportation companies and refiners as two intriguing subsectors. Two favorites in the fund are oil shipping firm OMI (Research) and refinery operator Frontier Oil (Research).
Waller adds that drilling stocks, which tend to be most sensitive to oil prices, look overvalued.
Analysts quoted in this story do not personally own shares of the companies mentioned and their firms have no investment banking ties to the companies.
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