"Prices Will Stabilize at High Historic Levels"


As consumers continue to face high energy prices, one consolation for investors could be the strength of energy stocks. That's a lesson to be drawn from the recommendations of Tina J. Vital, Standard & Poor's analyst of oil-and-gas stocks.

Vital points out that in the past year stocks in the energy sector of S&P's 1500 Super Composite Index rose 1.8% while the overall index fell 3.5%. And she predicts that prices for both crude oil and natural gas will remain at high historic levels, though they will taper off a bit in the next two years.

The industry will speed up spending on exploration and production, Vital says, and thus S&P has "buy" rankings on stocks of BJ Services, Ensco International, Global Marine, Noble Drilling, Rowan Companies, Santa Fe International, Nabors Industries, and Patterson-UTI Energy. Among the integrated oil companies she covers, the only "buy" recommendation is Exxon Mobil, but the stocks she has an "accumulate" on include Royal Dutch/Shell, Amerada Hess, Conoco, Occidental Petroleum, and USX-Marathon.

Vital's comments came in a chat presented June 12 by BusinessWeek Online and Standard & Poor's on America Online. Edited excerpts from the chat follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Tina, the market keeps giving us mixed signals. How does S&P view the outlook for energy stocks?

A: S&P recommends that investors overweight their exposure to the energy sector, which is broadly composed of oil and gas producers and major contractors that help the producers meet their exploration and production needs. As of June 8, the S&P energy index represented 6.85% of the S&P 1500 Super Composite Index, year to date. While the S&P 1500 fell 3.5%, the energy sector rose 1.8%, reflecting that earnings really do matter.

While many sectors struggle to produce positive earnings, the energy sector has continued to either meet or exceed analyst's expectations in earnings. However, the stock prices of most energy companies do not reflect the strong fundamentals and valuations within the energy sector. There has been volatility in the stock prices of the energy sector as the market adjusts to a new environment of low inventories, both on the crude oil and refined products side, tight production capacity, and greater field-depletion issues.

Q: Could you give us your projection of oil and gas prices? Do you see gas-pump prices coming down any time soon?

A: DRI-WEFA projects West Texas intermediate crude oil prices will reach over $28 per barrel in 2001, over $27 in 2002, and over $25.75 in 2003. Henry Hub natural gas prices (in dollars per million BTU) are projected to exceed $5.50 in 2001, exceed $4.80 in 2002, and exceed $4.40 in 2003.

Therefore, these projections indicate that oil and natural gas prices will stabilize at high historic levels. Because of this, we believe oil and gas producers should speed up their levels of spending on exploration and production projects. During 2001, S&P projects that worldwide spending for exploration and production [E&P] will rise over 20% to more than $110 billion.

Q: Can you translate those oil prices into any hope for near-term relief at the gas pump for drivers?

A: The price of gasoline is recalibrating into a higher level of demand. Demand for gasoline has grown 10% to 15% since 1997, but gasoline prices have not kept pace. Nationwide retail gasoline prices averaged $1.68 per gallon last summer, rising to above $2 in Chicago and San Francisco. This summer, I see gasoline prices topping last summer's high, reaching above $1.70 per gallon on average nationwide and way above $2 in some cities...

Q: You predict high spending on E&P -- which of your oilfield service and drilling stocks stand to benefit?

A: Major contractors that help the major oil and gas producers meet their exploration and production needs should be the main beneficiaries of increased spending this year. My "buy" recommendations within the oil service and drilling sector are BJ Services (BJS), Ensco International (ESV), Global Marine (GLM), Noble Drilling (NE), Rowan Companies (RDC), Santa Fe International (SDC), Nabors Industries (NBR), and Patterson-UTI Energy (PTEN)...

Q: Your opinion on Royal Dutch (RD)?

A: In May, we upgraded the shares of Royal Dutch Petroleum to "accumulate" from "hold," based on Royal Dutch/Shell's leading position in the upstream and downstream sectors and strong financial management.

Also, in May, Royal Dutch/Shell secured a coveted role as a leading investor in two of three core projects in Saudi Arabia's first extensive opening of its upstream sector to foreign investors since the 1970s. The venture, called the Gas Initiative, has been described as the world's largest oil and gas project and is designed to develop the natural gas infrastructure of the kingdom...

Q: Your opinion on Chevron (CHV)? And will the Texaco/Chevron merger be good for the companies?

A: I have a "hold" recommendation on both Chevron Corp. and Texaco (TX), although I believe the merger between Texaco and Chevron, which we expect to be completed by early September, should achieve savings of about $1.2 billion annually. These synergies, I believe, will take some time to be implemented. Therefore, I would only hold Chevron for now.

Q: This is a good place to ask for your "buy" choices among the integrated oil companies. How about it, Tina?

A: My "buy" recommendation among the international integrated oils is Exxon Mobil Corp.(XOM), the largest publicly traded oil company. We recommend the stock as a safe haven, with growing cash flows and an active share repurchase program. The company's substantial business and geographic diversification moderates its exposure to business risk and earnings volatility.

In May, Exxon Mobil secured a role as a leader and operator in two of three core projects in the Saudi Gas Initiative. Exxon's return from this investment is expected to exceed 15%. The company trades at 17 times our projected 2001 earnings per share forecast of $5.33 -- at a premium to its peers, but at a discount to the S&P 500, as the market rewards the behemoth for its earnings stability.

Q: Is XOM your only "buy" in that group?

A: Yes. However, I have some excellent "accumulate" recommendations: Royal Dutch/Shell Petroleum (RD) and Shell Transport & Trading (SC) -- and the following domestic integrated oil companies: Amerada Hess (AHC), Conoco (COC), Occidental Petroleum (OXY), and USX-Marathon Group (MRO).


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