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The Power Behind Energy Stocks

Iraq's alleged program to develop weapons of mass destruction has been headline news ever since George W. Bush took office. An armed conflict with that country -- one that has the potential to cause serious disruptions to global oil supplies -- is looming ever closer. It's little wonder, then, that two industries among the top 10% in the S&P Super 1500 based on trailing 12-month price performance come from the energy sector.

Which of the two should be highlighted in this week's column? Since the industries' inclusion in the Industry Momentum portfolio is based on relative strength, I have chosen the stronger of the two -- the S&P Exploration & Production (E&P) group. That industry index rose 12% in the past 52 weeks, while the S&P Oil & Gas Drillers index gained 10.5%.

BELOW PEAK. During 2002, the S&P Oil & Gas E&P index was the only subindustry index in the Energy sector to post a gain. It eked out a 0.4% advance, vs. the S&P 1500's decline of 22.5%. S&P analyst John Kartsonas believes the group will outperform the broader market in the next 9 to 12 months as production declines and improving demand supports stronger natural-gas prices.

Kartsonas notes that these stocks usually trade in tandem with commodity prices. However, the E&P group was recently trading below the 2002 peak it reached in the spring, despite the fact that natural-gas prices are at 1-year highs and oil remains above $30 per barrel. Economic forecasting group Global Insight expects U.S. natural-gas prices to average $3.66 per million BTU in 2003, up from 2002's average of $3.26. (BTU, or British thermal units, is a widely used measure of energy. One BTU is the amount of heat required to raise one pound of water one degree Fahrenheit.)

As economies worldwide take their first tentative steps toward recovery, economic forecasting outfit Global Insight projects global oil demand will rise more than 1% in 2003. Oil supplies should respond proportionately. OPEC recently agreed to raise production quotas to 23 million barrels per day (mbd) from about 21.7 mbd, while taking steps to rein in overproduction by member states. OPEC historically has targeted a price between $22 and $28 per barrel. As of Jan. 21, the OPEC price was $30.90, mainly reflecting the effects of lost production from Venezuela due to the ongoing general strike in that country.

LOWER INVENTORIES. The outlook for natural-gas prices is positive for the industry over the long term, according to Kartsonas. Although natural gas spiked above $5 per million Btu recently -- reflecting cold winter weather as well as declining U.S. production -- Kartsonas thinks in the intermediate term, prices should remain around $4.50 per million Btu. Inventories remain below average levels. According to the Energy Information Administration, as of Jan. 10, 2,195 billion cubic feet of gas were in storage, 1.8% below the five-year average.

Global Insight forecasts total demand growing by 2% in 2003. With U.S. gas-field depletion rates reaching 30% per year and imports limited by infrastructure constraints -- in pipelines as well as vessels and facilities that transport and process liquefied natural gas -- Kartsonas believes domestic natural-gas supply and demand economics will remain tight in the future.

While the fundamentals are strong for the entire industry, Kartsonas has three particular favorites in the group: Apache (APA), Ocean Energy (OEI), and EOG Resources (EOG). S&P ranks them all 5 STARS (buy).

Industry Momentum List Update

The following are the 11 industries in the S&P Super 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the 116 industries in the S&P 1500) as of January 17, 2003.


Largest Company (Market Cap.)


Apparel, Accessories & Luxury Goods/Consumer Discretionary

Quiksilver (ZQK)


Commodity Chemicals/Material*s

Lyondell (LYO)


Consumer Electronics/Consumer Discretionary

Harman International (HAR)

Not Ranked

Diversified Metals & Mining/Material*s

Freeport-McMoran Copper & Gold (FCX)


Fertilizers & Agricultural Chemicals/Materials

IMC Global (IGL)



Newmont Mining (NEM)


Housewares & Specialties/Consumer Discretionary

Newell Rubbermaid (NWL)


Metal & Glass Containers/Materials

Pactiv (PTV)


Oil & Gas Drilling/Energy

Nabors (NBR)


Oil & Gas E&P/Energy

Apache (APA)


Photographic Products/Consumer Discretionary

Eastman Kodak (EK)


*S&P's ranking system for the appreciation potential of stocks over a 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).

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