The Rewards of Burning the Midnight Oil


By Robert Barker Andy Pilara has guided his RS Global Natural Resources Fund deftly amid the recent bear market, keeping a watchful eye on situations that could affect the oil supply

About the only thing more difficult to forecast than the weather is the price of crude oil. Not only is it a hypersensitive barometer measuring global economic activity, it can soar or plunge on the faintest political vibration from some of the world's hardest-to-plumb places.

Just the same, predicting the price of oil is a big part of many investors' jobs. San Francisco-based Andy Pilara, manager of RS Global Natural Resources Fund (RSNRX), is no exception. At less than $35 million in assets, the fund is relatively small. Yet Pilara has navigated it deftly through the bear market. On the strength of its performance this year, Morningstar ranks Pilara's fund in the top 8% of its peer group. Through Nov. 1, the fund had lost 3%, vs. 17% for the Standard & Poor's 500. Last year, it gained nearly 26%, while the S&P 500 lost nearly 10%.

Today, forecasting oil is complicated by the war in Afghanistan -- a situation that many people thought might have boosted crude's price well above its recent level of nearly $22 a barrel. That's a good shot below the $27 it brought before September 11.

RUSSIAN CRUDE. The war might still send oil soaring. Crude prices, Pilara told me, "are so event-driven that any economic analysis could be thrown out the window immediately" by events in the region. As it is, Pilara estimates the war has imposed a $3- to $4-per-barrel premium on the price of oil. The current level of crude inventories, along with the continuing slowdown in demand for energy as the world's economies recede, indicates price would otherwise be about $19 a barrel. Pilara doesn't expect that relatively benign supply-demand picture to change soon, as he sees the world's thirst for oil remaining low until well into next year.

What's more, there is a new factor that is also moderating prices: Russia's reinvigorated oil industry. Pilara notes that some 70% of this year's extra supply was pumped from Russian wells -- crude that the Russians are only too happy to put on the world market in return for hard currency.

While the Russians could in no way produce enough oil to make up for a major disruption in the flow from the Persian Gulf, Pilara thinks that Russia can export enough to give Moscow its "first new lever in geopolitics subsequent to the Cold War." Adds Pilara: "It's a new reality, and it's a little different from dealing with the Saudis. We offer the Saudis protection, so it's a quid pro quo." Russia, on the other hand, doesn't need protection from the U.S.

WEAK SPOT. All in all, through next spring or even fall, Pilara sees prices staying in the low $20s -- barring further outbreaks of geopolitical strife. One huge and apparently growing threat to the oil-consuming nations, including the U.S., is the potential for instability within Saudi Arabia. As the divide between the Saudi people and its royals widens, that danger increases. In Pilara's view, Saudi Arabia has "the weakest government in the Mideast." If the regime were to collapse and the resulting turmoil interrupted the flow of oil from the world's No. 1 exporter of crude, "the investment implications are scary."

Some analysts worry that a serious disruption in Saudi oil supplies could mean $60-a-barrel oil. While Pilara relies on consulting researchers for his take on Saudi politics, another longtime OPEC watcher -- an expert who agreed to speak with me on condition that I did not identify him and his firm -- thinks the possibility that Osama bin Laden might return to Saudi Arabia and topple the current regime is far from fanciful.

Here's one scenario: In late February next year, as Muslims from around the world journey to Saudi Arabia for the annual hajj, or pilgrimage to Mecca, bin Laden commandeers a commercial airliner and leaves Afghanistan to join the air procession to the sacred city, flying over Iran and Iraq. Shooting his plane down would be no simple matter for the U.S. or its allies.

NIGHTMARE SCENARIO. Once in Mecca, bin Laden would surround himself with other pilgrims. "I don't think the police force would dare to shoot into the crowd," this analyst told me. "The next thing you know, [Saudi royals] would be on the next planes out to Europe." Bin Laden could cut oil output nearly in half, from 8 million barrels per day to less than 5 million, and still provide for the Saudi people as well as the current regime has done. The price of oil might then leap to $60 a barrel.

Pilara doesn't share this view. But over the summer, he reduced the fund's energy-stock exposure from 51% to around 35%, buying such natural-resource plays as agricultural giant Fresh Del Monte Produce (FDP) in the U.S. Among energy companies, he likes Canadian outfits with natural-gas exposure. He particularly favors PanCanadian Energy (PCX), recently spun off by Canadian Pacific. "We just love their asset mix and their exploration mix," Pilara says, noting that 60% of the company is in natural gas.

Over the next few weeks, ironically enough, Pilara expects stocks with heavy exposure to natural-gas prices to sink as large inventories depress the market. As far as he is concerned, however, that spells opportunity to make longer-term investments in the sector.

GLOBAL PERSPECTIVE. What is Pilara avoiding? He continues to spurn the stocks of U.S. oil producers, figuring that while they face the same risks as other energy stocks, they have too few avenues for growth as domestic oil production continues its long decline.

After 30 years in this sector of the stock market, Pilara has concluded that "geopolitical events are almost impossible to analyze." So he focuses instead on forecasting companies' fortunes, all the while keeping a weather eye for brewing political storms. Right now, if you're interested in energy stocks, his perspective might be a good one to emulate. Barker covers personal finance in his Barker Portfolio column for BusinessWeek. His barker.online column appears every Friday, only on BW Online


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