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Oil Is Heating Up Again


The war's over, but high oil prices may not be. The price of oil dropped sharply in the wake of the Iraqi war but has since bounced back to more than $30 a barrel, suggesting that higher prices may be here for a while. "The new reality is that inventories are at record lows, Iraq's restart is slow, and OPEC has breathing space across the summer," says J.J. Traynor, an oil analyst at Deutsche Bank Alex. Brown (DB)

The story looks different with natural gas. It has been a hot commodity for so long -- with prices remaining above $6 per million BTUs even in the slow summer months -- that no less than Fed Chairman Alan Greenspan is sounding the alarm that supplies are getting tight. That could spell trouble for gas stocks if companies rush to increase drilling and boost output, thus driving prices down.

So when it comes to energy stocks, many investment pros are recommending companies focused on oil. Mitchel B. Schlesinger, chief investment officer at Bethesda (Md.) money manager Fulton Breakefield Broenniman, has been steering clients into two big companies that are digesting major acquisitions. ChevronTexaco took unexpectedly large write-offs last year on some of its oil and gas assets. The San Ramon (Calif.) company also has been stung by its billion-dollar investment in troubled energy trader Dynegy (DYN). Schlesinger thinks the bad news is now behind it. "We've already seen Chevron begin to beat earnings targets," he says. Schlesinger figures the company will earn $5.70 a share this year, giving it a below-market multiple of 13 times expected earnings.

Schlesinger also likes ConocoPhillips, the Houston-based producer that completed its merger last year. He thinks the company will achieve its projected $1.2 billion a year in cost savings and earn upwards of $5.30 per share this year. In addition to expanding oil and gas production in places such as China, Venezuela, and Australia, ConocoPhillips is now the largest refiner in the U.S. That business should do well as the economy turns and gasoline consumption continues to climb.

Refiners that have been consolidating could prove rewarding. Friedman, Billings, Ramsey Group oil analyst Jacques Rousseau's top pick is lesser-known Frontier Oil, which is acquiring Holly, another small refiner. That will give Frontier five of the nation's most sophisticated refineries in niche markets such as Cheyenne, Wyo., and Great Falls, Mont. "They're moving up the ranks in terms of capacity," Rousseau notes. "And they are in markets where you don't have as much competition." He figures Frontier will earn $2.30 per share this year and $2.45 next year.

Canadian companies also look attractive given their strong growth in oil production and proximity to the world's largest energy market in the U.S. Roger Mortimer, lead portfolio manager of the $45 million AIM Global Energy fund, has put 40% of his assets into the likes of Shell Canada, a publicly traded subsidiary of the Anglo-Dutch giant Royal Dutch Petroleum (RD). "You're buying an extremely large, low-risk player with visible growth ahead," he says. Shell Canada, like another top Mortimer pick, Suncor Energy (SU) is a big player in Alberta's oil-sands industry, which mines bitumen, a sticky form of crude, from under layers of clay, silt, and gravel. "It's more like manufacturing oil than exploring for it," Mortimer explains. "Once you've built infrastructure, the cost is low."

As for natural gas, there are still buys. David R. Tameron and Jeffrey N. Schleppy, oil-and-gas analysts at Stifel, Nicolaus, have found a safer way to play that market by investing in Western Gas Resources (WGR). The Denver-based company has doubled its Rocky Mountain natural-gas production over the next three years. But Western also generates a steady stream of cash by collecting and processing gas for others via its extensive pipeline network. Tameron and Schleppy see Western earning $2.63 per share this year, more than double last year's earnings. So even if the surge in prices runs out of gas, there's still plenty of money to be made by energy investors. By Christopher Palmeri


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