Markets & Finance

Sizing Up the New Oil Spike


Analysts are divided about the reason for rising prices. Is it lower inventories or the falling dollar? In any event, oil companies should clean up

So much for the oil bust. It seems like only yesterday that oil had sunk to $30 a barrel. (In fact, oil traded near $30 on Dec. 22.) But with the temperatures heating up and the summer driving season upon is, crude is on the rise: Oil snapped back to over $65 in late May, and everyone's wondering how much higher it can go.

What's going on here?

Some point to the decline in oil inventories, which Energy Dept. data showed dropped 5.4 million barrels in its weekly report released May 27. The decline in supply, however, was met with another large drop in demand, which fell 5.4% in March, according to the most recent Petroleum Supply Monthly report released by the Energy Information Administration.

Falling Dollar a Factor

Others mention the forward-looking nature of the markets. "Oil is looking ahead," says T. Rowe Price (TROW) oil analyst Tim Parker. "When it was at [below] $40, it was looking to how bad 2009 would be," he notes, and the economy thus far in 2009 has proven to be "awful." Now, oil may be looking ahead and seeing better times. Whether the economy does recover, of course, is anyone's guess.

Then there's the falling dollar. When the greenback is weak, oil prices tend to rise, and right now, the dollar is very weak. After rising 15% against the euro at the height of the financial crisis, the dollar is now back to pre-crisis prices—around €1.40. That can't help but push the oil prices higher.

With oil finishing May at $65, analysts are placing bets as to what happens next. Some, like Kanaly Trust Chief Investment Officer James Shelton believe oil has gotten ahead of itself. In a global economy that's firing on all cylinders, oil should move higher simply based on supply and demand. But that won't happen "until we get a true economic recovery," Shelton says. In the meantime, prices could pull back.

Bullish on Oil Services

TD Bank Financial Group (TD) economist Dana Carver sees price volatility ahead. "We suspect that the tug-of-war between the weak fundamental picture and a further depreciation in the greenback will persist over the next few quarters," she says. Barclays (BCS), on the other hand, sees oil going to $75 soon. "When the market as a whole starts to believe that $75 is pretty much inevitable, then it might as well go straight to it," Barclays analysts wrote in a report on May 29.

The rise in oil prices is, of course, good news for stocks of energy-related companies. Start with the oil services stocks. With the rise in oil prices, producers everywhere will start looking to drill. "Once the price gets up, the first industry to go to work will be the companies that provide services to the oil industry," says Don Hodges, portfolio manager of the Hodges Fund (HDPIX). Citigroup (C) recently raised its price targets for oil services stocks, including Baker Hughes (BHI), BJ Services (BJS), Halliburton (HAL), and Schlumberger (SLB).

Oil producers stand to benefit as well, says T. Rowe Price's Parker, who likes Murphy Oil (MUR), Hess (HES), Whiting Petroleum (WLL), and Continental Resources (CLR). He especially likes Petrobras (PZE), because Brazil has the world's largest non-OPEC reserves.

Cash Flow for Oil Drillers

But it's the oil drillers who have benefited the most from the rise in oil, with companies including Atwood Oceanics (ATW), Ensco International (ESV), and Transocean (RIG) up over 50% since the stock market bottomed on Mar. 9. Even if oil has gotten ahead of itself, the drillers don't need $100 oil to thrive, says Dennis Bryan, co-manager of FPA Capital Fund (FPPTX), a value fund with $766 million in assets. If oil stays in a range of $50-$75, he says, "these companies are going to generate a tremendous amount of cash flow and earnings."

Levisohn is a staff editor at BusinessWeek covering finance and personal finance.

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