China's government "gets it" far better than Washington when it comes to energy policy. To Stephen Leeb, president of Leeb Capital Management and author of The Oil Factor, that's the real message of the bid by China National Offshore Oil Co. to take over Unocal (UCL ) -- a company also sought by Chevron (CVX ).
"They're doing this because they believe oil prices are heading dramatically higher over the longer term," says Leeb, who agrees with that forecast. And he adds that, like any astute investor, the Chinese are trying to own as much of such a commodity as they can. In his eyes, the only valid issue is whether CNOOC has been financed in an unfair way.
Leeb still sees many energy stocks as good buys because they're valued as if oil prices are going to come down by as much as 30%, which runs quite contrary to his view (see BW Online, 7/5/05, "Energetic Disagreements on Oil"). Specifically, he names Nabors Industries (NBR ), Suncor Energy (SU ), and the oil producers, as well as what he calls "interesting alternative energy plays," such as Air Products & Chemicals (APD ), FPL Group (FPL ), and Exelon (EXC ).
In the area of alternative energy, he feels particularly upbeat about the potential for wind, an area where he thinks the leaders include FPL Group, General Electric (GE ), and Scottish Power (SPI ).
Leeb made these and other points in an investing chat presented June 30 by BusinessWeek Online on America Online, in which he responded to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from this chat (AOL subscribers can find a complete transcript at aol.businessweek.com/chat):
Q: Steve, what's your forecast now for oil prices and their effect on the stock market -- which is, of course, a big area of expertise for you?
A:I believe oil prices' uptrend will remain. It won't be straight up, but by and large the factors that have caused oil to go from $10 a barrel in '98 to more than $50 now are very much in place. Demand for oil is very much in place, given the expanding economies in India and China, whereas the supply is ever more limited.
So the only question for me is, short-term dips notwithstanding, how quickly oil prices rise in the forthcoming period -- not whether they'll increase, but how quickly they'll increase.
Q: The Federal Reserve just raised interest rates again. How much longer do you think the Fed will stay on this path?
A:My guess is not too much longer. Today, as you pointed out, the Fed did raise rates. But this was nullified in effect by a rally in the bond market. The markets are positioned at this point such that the more the Fed raises rates, the greater the risks to the economy -- and the lower long-term bond yields go.
So they're relatively powerless, the Fed. It's only a matter of time before they wake up to this. Long-term rates are far more important than short-term rates in their impact on inflation and general economic activity.
Q: What are your favorite energy plays? Is it too late to get into the sector?
A:No, it's not too late. Hard to believe, but virtually no Wall Street analyst believes that oil prices are going to stay in an uptrend. What this means is that energy stocks are currently valued as if oil prices are going to come down -- and come down a lot (30% or more), over the next three to five years. Plus, if I'm right, the entire energy sector is exceptionally cheap. Beyond the usual suspects such as Nabors Industries, Suncor Energy, and the oil producers are some interesting alternative energy plays. These include Air Products & Chemicals, FPL Group, and Exelon.
Q: I would welcome your opinion on EnCana (ECA ) and Transocean (RIG ).
A:Both those stocks are in our portfolio, and we like them both very much. EnCana, as with Suncor, has a stake in the Canadian oil sands and has an excellent production future -- i.e., it's going to be increasing in the foreseeable future. Combine that with rising oil prices, and you have a genuine growth stock, which is trading at a very modest multiple of less than 13 times earnings.
As for Transocean, it is by a wide margin the most significant and largest deepwater driller for oil, and if there are any additional significant hydrocarbons to be found in the world, they're going to be found in the deepest waters. This highly leveraged driller should see torrid growth for many years.
Q: What's your take on the China National Offshore Oil Co. (CNOOC ) takeover bid for Unocal (UCL ) and whether it might be -- or should be -- blocked in Washington?
A:I don't think that the bid should be blocked simply because China is trying to buy oil assets. The security argument rings hollow. What China buys from Unocal it won't buy from other sources in the world. So we really don't have an overall issue regarding security.
However, if it's determined that CNOOC was financed in an unfair way by the government, that should be considered. If Chevron got a loan from a state and used it to do something unethical, that would also be investigated.
In this I feel very strongly that the public, rather than focusing on China's buying U.S. oil assets, should focus on why they're buying these assets, and why they're doing something that will clearly result in repercussions in Washington.
My take is that they're doing this because they believe oil prices are heading dramatically higher over the longer term. Like any investor, if they believe any commodity is heading dramatically higher, they want to own as much of it as they possibly can. I think the Chinese government "gets it" as far as energy goes much more clearly than we do. For me, that is the real message of the CNOOC bid.
Q: Is now the time to buy Chevron (CVX ), considering the bidding war with China? Or Unocal (UCL )?
A:I think Chevron's a fine company to own. We don't recommend it that aggressively because we believe there are better values in the sector. But for anybody wanting income and a stake in rising energy prices, Chevron, with a 3% yield, is certainly a solid holding.
As for Unocal, I would not recommend it. It's no longer an energy stock at this point in time -- it's a stock involved in a bidding war. We'd leave it to the U.S. Congress to determine where they're headed. I would add, though, that were Chevron to prevail and buy Unocal, even with a bid 10% higher than CNOOC's, I would regard it as a long-term positive for Chevron.
Q: What can an individual investor do to make profits in this volatile environment?
A:That's a very good question. The market has been a very difficult one, but I believe that the energy sector is undervalued, if you believe oil prices are going higher, and it certainly has been one of the few consistently rewarding sectors around. I don't see anything coming that will change that.
We would also be looking at metals, particularly gold and silver. Long-term interest rates are currently not much above the inflation rate. In economic terms, that means real interest rates are very low. Historically, that has been a very strong correlation with rising gold prices. So it could be that, as in the 70s, our market is going to be fractured, in which a very few sectors, gold and energy, do extremely well, but the rest of the market lags significantly.
Q: Won't alternate energy sources eventually bring down oil prices?
A:I hope so. That's a very complicated question. The short answer is, eventually, yes. But the caveats include extremely long lag times between bringing on alternative energies, between the planning and fruition stages in these alternative sources. For example, were we to start building a new nuclear plant today from scratch, it could easily take as long as a decade to finish.
For me, and I realize I'm on a soapbox right now, by far the most interesting alternative energy is wind. In the June 24 issue of Science magazine, there's a peer-reviewed article by a Stanford professor who argues that electricity generated from wind could economically generate, via downstream production of hydrogen gas, enough to fuel the entire vehicle fleet in the U.S.
Clearly, this is an aggressive statement, but it does come from a very reputable source in one of the most reputable science magazines in the world. The biggest players in wind, in case you want an investment angle, would be FPL, General Electric, and Scottish Power (SPI ).
Q: Do you see any near-term opportunities in the oil-equipment segment?
A:If you mean stocks like Halliburton (HAL ) and Schlumberger (SLB ), I think they represent wonderful opportunities. We'd advise accumulating shares in both.
Q: What's the best way for investors to play the strong economic growth in China?
A:Certainly oil represents a very good play in China, but so do many other companies. Indeed, any company that has an established and strong presence in China is a very good investment. Some of our favorites include Coca-Cola (KO ), for whom we believe China will turn out to be another Japan, perhaps even more significant. Plus Procter & Gamble (PG ), Intel (INTC ), and Texas Instruments (TXN ).
In all these cases, we believe these companies will be able to sustain unit growth of 15% or so for the foreseeable future. Combine that with very probable currency gains from the appreciation of the Chinese currency, which is inevitable, and you have companies looking at very rapid growth for a long, long time.
Q: Is it economical to go after the tar sands in Canada?
A:It's economical, and indeed, Suncor, EnCana, PetroCanada (PCZ ), and Canadian Oil Sands Trust (COSWF ) are four companies with very strong production growth rates by virtue of their stake in the tar sands. However, there's a limit to what we can expect the tar sands to produce, as mining these sands happens to be energy-intensive and unfriendly to the environment. Still, this should be a very fruitful area for many years, and each of these four companies should be very strong performers.
Q: Earlier you recommended gold stocks -- does that mean you expect serious inflation?
A:I do. Again, I hope I'm very wrong on this, as I hope I'm wrong about oil. So don't shoot me -- I'm just a messenger. But, in addition to rising oil prices, the U.S. and world have to contend with very high debt levels, which will make it very hard for central bankers to control inflation without risking massive recession.
And for those who follow long-term cycles, over the last 90 years there have been three periods of double-digit inflation, each coming 30 years after the other. The last was in the mid and late '70s, which does suggest we're due for another.
Q: How do oil prices and interest rates combine to affect the U.S. economy? Do you see a slowdown coming?
A:I think oil prices have to eventually slow down the U.S. economy and, at the same time, have to also lead to higher inflation. In other words, very likely stagflation. This means we may be in the very unfortunate situation where long-term rates start to rise while the economy starts to slow.
Q: Are there any interesting investments to be had in the biofuels industry?
A:Not really. Perhaps Archer Daniels Midland (ADM ) in the ethanol area. But I don't believe ethanol is a meaningful source for alternative energy. I think we should be funding biofuels, and there's some interesting technology concerning ways of converting carbohydrates into fuel, but at this point, the technology is very interesting but quite expensive. Funding this technology is something the government should be doing whole hog.
Q: This bears strongly on consumer spending -- do you think the American public has adjusted to gasoline prices?
A:I think the American public has, in fact, adjusted to gasoline prices, in that gasoline consumption has been rising at about a 2% rate year-over-year, despite higher gas prices. This will not always be the case, in that as gasoline prices continue to rise, gasoline will become ever more important in the consumer's pocketbook, and adjustments will be that much harder to make. This is not an issue on which to become complacent, as gasoline prices will eventually hurt -- and hurt a lot.
Q: You mentioned plenty of stocks earlier, but what are your favorites at this stage?
A:In addition to all those that I've mentioned in the oil patch, and those companies such as Intel, Texas Instruments, and others leveraged to China and India, we also like Internet companies. Recommendations in this area (our favorites) are eBay (EBAY ), Yahoo! (YHOO ), and Microsoft (MSFT ).
Edited by Jack Dierdorff