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Still Lots of Heat in Fossil Fuels


Despite a big runup in 2007, oil and gas producers and refiners remain a big play for investors

Energy is in the spotlight. Consumers and businesses are grappling with tight oil and gas supplies, while oil companies and a host of new players struggle to come up with sustainable energy sources that cut CO2 emissions. It's a bafflingly complex challenge that is unlikely to be solved anytime soon.

One thing that seems sure amid the uncertainty is that energy, regardless of the source, is likely to become more expensive. That should make energy stocks a good bet over the next few years. Since the world will remain dependent on oil and gas for the next couple of decades at least, shares in companies that extract those substances from the earth or refine and market them will remain the big plays.

The only caveat is these stocks already had a good run in 2007. For instance, the CBOE.OIX index of 11 oil companies is up 32.1% on the year, vs. just 4.9% for the Standard & Poor's (MHP) 500-stock index. Fadel Gheit, an analyst at Oppenheimer & Co. in New York, says investors jumped on any stocks related to energy in 2007.

SMALLER IS BETTER

Already high prices could give energy stocks less room to run in 2008. Gheit thinks that if energy prices continue to rise, smaller companies are a better bet than the heavyweights such as ExxonMobil (XOM) and Chevron (CVX). Among the independents, he recommends Noble Energy (NBL), which has doubled production since 2000, and Apache (APA), which specializes in squeezing oil from older fields. Eitan Bernstein, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Va., thinks two stocks worth considering are Occidental Petroleum (OXY) and Valero Energy (VLO). Occidental, a medium-size company, has reclaimed its old concessions in Libya, one of the world's most promising oil countries. Valero, the largest U.S. refiner, is selling off less profitable properties after an acquisition binge and is buying back stock.

A special case, Gheit says, is BP (BP), which has been battered by a spate of spills and accidents. Gheit estimates BP has lost $5 billion in the past 30 months because of refinery outages and delayed projects. Bringing two damaged refineries back up to capacity and starting up two new fields in the Gulf of Mexico, Gheit figures, will add up to $3 billion to the bottom line by 2009. He thinks the earnings boost could be 15% on a per share basis.

Malcolm Polley, president and chief investment officer of Pittsburgh-based Stewart Capital Advisors, which manages $1 billion, says while the majors are usually safe bets, he prefers trying to pick home run candidates. His choices include oil-field services companies such as Halliburton (HAL) and Schlumberger (SLB), which are profiting from all the drilling and exploration. Another good prospect is Transocean (RIG), the largest offshore driller.

Investors also would be smart to figure out a way to buy into the fast-growing business of liquefied natural gas, formed by supercooling natural gas so it shrinks and can be transported on ships. The volatile stuff is being traded like oil, and worldwide demand is huge. But the only major LNG-producing country accessible to equity investors is Australia. Bernard J. Picchi, an analyst at Wall Street Access in New York, recommends Woodside Petroleum (WOPEY). It's well-entrenched in the growing Australian gas fields, and may be subject to a takeover offer by Royal Dutch Shell (RDSa), which owns 34%.

Oil and gas alternatives have a bright future, but it isn't easy to figure out which energy sources or companies will prove the big winners. Adventurous investors could look at VeraSun Energy (VSE), a Brookings (S.D.) ethanol producer, which had net profits of $22.6 million on revenues of $535 million for the nine months ending Sept. 30. Pavel Molchanov of Raymond James Financial (RJF) in St. Petersburg, Fla., says VeraSun is the industry leader but warns: "Ethanol is a challenging industry because of the oversupply in the U.S." Molchanov also favors SunPower (SPWR), a San Jose producer of solar panels and cells, which is majority-owned by Silicon Valley icon Cypress Semiconductor (CY). But it's too early to know whether one of these young companies is tomorrow's ExxonMobil.

Back to Investment Outlook 2008 Table of Contents

Reed is London bureau chief for BusinessWeek . Herbst is a reporter for BusinessWeek.com in New York .

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