By Sam Stovall After a brief period of decline, crude oil prices are marching higher again, with the benchmark West Texas Intermediate grade moving back above $50 a barrel on Feb. 22. And elevated crude prices have helped stocks in the energy sector to post some eye-catching returns. Year to date through Feb. 18, the S&P Composite 1500 Energy Index rose 15.5%, vs. a 0.8% decline for the broad market benchmark. And for all of 2004, the energy sector jumped nearly 30%, while the "1500" rose 10%.
With that strength, it should come as no surprise that four of the five subindustry indexes in this sector have landed on the industry momentum list. They represent a third of the subindustries with 12-month price performances in the top 10% of all subindustry indexes in the S&P 1500.
But that robust performance also raises a question: Have these subindustries come too far to be worth investing in now? Here's a look at what S&P equity analysts think of the prospects for the four subindustries on this week's list:
Integrated oil and gas: Tina Vital covers the international integrated oil stocks for S&P. Her investment outlook for this "supermajor" group is positive. With most supermajors finished with their recent restructuring program, she believes they're now focused on long-term projects in deep-water areas, liquefied natural gas (LNG), and in frontier regions that offer growth at a reasonable cost.
She views these supermajors as benefiting from high oil and gas prices through exploration and production, yet believes their diversified businesses globally should help mitigate commodity price as well as economic and geopolitical risk. She believes these companies balance their requirements of return on investment with upstream spending to keep pace with field decline rates.
Refining and marketing: Vital also covers the independent refiners. Her investment outlook on these companies is also positive. While global supply of crude oil appears adequate to meet demand, the mix has shifted towards heavier grades that are high in sulfur (a primary cause of acid rain), creating a disconnect between the supply growth of heavy crude oil feedstocks to the refinery and the demand for their light sweet (low-sulfur) refined products. With refining capacity limited and an increased supply of lower quality crudes, Vital believes heavy crude oil refiners will continue to benefit from feedstock discounts and that the fundamentals for refining will remain strong over the next 12-months.
Drilling: Stewart Glickman covers the oil and gas drilling stocks for S&P, and he, too, is positive on this group. Why? Glickman cites anticipated favorable industry fundamentals and S&P's view that capital spending should remain high, particularly in international regions with low-cost drilling opportunities. In the onshore North America market, which has seen a marked increase in rig activity over the past 12 to 18 months, available equipment is extremely scarce, notes Glickman, and S&P thinks that the rates that drillers charge to provide and operate equipment (dayrates) should accelerate as a result.
In the Gulf of Mexico, Glickman sees a slight uptick, based mainly on tight supply, which should translate to higher dayrates for jackup rigs -- with some capable of working in water up to 550 feet deep. The greatest gains are likely to occur on the premium jackups. The markets for semisubmersible rigs -- capable of drilling in deep waters -- continue to improve, with recent contracts at high dayrates.
Exploration and production: The S&P Oil & Gas Exploration & Production group is followed by Charles LaPorta, CFA. He believes the investment outlook for independent oil and gas exploration and production (E&P) is slightly positive. LaPorta thinks the market's legitimate concerns on the supply side (e.g., potential for disruptions given the current difficulties in the Middle East, Russia, and Nigeria) and the demand side (e.g., S&P projections for U.S. real GDP growth of 3.7% in 2005) have led to persistently elevated oil price levels, and he believes the lack of a foreseeable resolution should continue to allow the E&P companies he covers to earn superior returns on capital.
So there you have it. From both a fundamental and momentum standpoint, S&P believes the investment outlook for oil-related issues is favorable over the coming 12 months.
Industry Momentum List Update
For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), their proxies (the highest STARS-ranked companies in the sub-industry index-tie goes to the largest market value) as of February 18, 2005.
S&P STARS Rank
Fertilizers & Agricultural Chemicals
Home Entertainment Software
Integrated Oil & Gas
Managed Health Care
Oil & Gas Drilling
Oil & Gas E&P
Oil & Gas Refg., Mktg. & Trans.
Stovall is chief investment strategist for Standard & Poor's