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A Good Time To Drill For Energy Bargains

A Good Time To Drill For Energy Bargains

It costs more to fill the fuel tank in your car these days, and you've noticed that your neighbors are all driving sporty gas guzzlers. Meanwhile, the press is still gushing about last year's record profits in the oil patch. Have you missed the chance to strike it rich by investing in energy stocks?

BLACK GOLD. Hardly. Investors willing to take on a little extra risk and explore beyond the big-name oil companies can still uncover black gold. Analysts advise people to dig into the energy-service companies that supply drilling equipment, crews, and seismic data to the major oil companies. True, the service sector was a 1996 standout. The Standard & Poor's Oil-Well Equipment & Services index returned 44% last year, vs. 25% for the S&P 500-stock index. But analysts insist there are further gains to be made. A January thaw has melted the prices of many energy shares, so a number of companies are trading below their recent peaks.

"I've seldom seen a better time to invest," says William Walker, president of Howard Weil Labouisse Friedrichs, an energy investment firm in New Orleans. Walker's optimism reflects rising budgets for exploration and production, demand for energy, and the sector's recent weakness. His latest recommendations include such 1996 market stalwarts as Baker Hughes, Schlumberger, Halliburton, and two stocks that have tumbled amid the small-cap sell-off this year: Houston-based Seitel, which analyzes seismic data, and New Orleans-based Tidewater, a marine transporter.

Strong crude and natural-gas prices have major oil companies hiking spending on exploration and production 7% to 8% this year. Some are planning to spend even more. Atlantic Richfield, for example, will increase its spending by 24%, Mobil by 17%, and Texaco by 22%. A broader survey of 92 mostly smaller oil companies by Arthur Andersen found that 70% of the companies are planning to raise spending on domestic exploration and development projects. And two-thirds plan to keep spending levels high overseas.

Diamond Offshore Drilling, which supplies the majority of the rigs used in the deep waters off the Gulf of Mexico, is a prime example. Wall Street expects earnings of the Houston-based company to rise 75% this year, to $257 million, thanks to a shortage of drilling rigs. With 92% of the world's offshore rigs now under contract, Diamond is in an ideal position. Indeed, 20 of its 46 rigs will come off existing contracts this year. And "new contracts will be at much higher day rates, which will lead to accelerating earnings in 1997," according to Salomon Brothers analyst Mark Urness.

Some analysts are even betting on a cyclical return to prosperity in the long-depressed oil-refining market. "This is the only area in industrial America that hasn't had an upturn in the current business cycle," says Morgan Stanley analyst Douglas Terreson.

PURE PLAYS. There are indications that such a turnaround may already be taking place. A rising tide of low-quality crude imports is cutting U.S. refiners' feedstock costs. What's more, consolidation among gasoline retailers should raise profits for refiners, such as Ultramar Diamond Shamrock and Tosco, that own their own service stations. Terreson's picks include Tosco, based in Stamford, Conn., and Bharat Petroleum, a Bombay refiner that could benefit from the deregulation of India's oil industry. Two U.S. refining pure plays that should also profit from a cyclical upturn: Valero Energy in San Antonio and Ashland in Russell, Ky. Each is spinning off nonrefining businesses.

What about the major oil companies such as Exxon, Shell, and British Petroleum? Despite record 1996 profits and fatter dividends, integrated oil companies only matched--but didn't beat--the gains of the Standard & Poor's 500-stock index last year. And prospects are no better this year. Current prices for crude and natural gas are healthy but should fall well below last year's peaks of $26 a barrel for crude oil and $3 per thousand cubic feet for natural gas. With crude now selling at $21.11 a barrel and gas at $1.83, profit gains won't measure up to 1996--hardly a scenario for a good run among investors. So if you're antsy to own some of the pricier oils, there's always the local gas station. Just pull in and say, "Fill 'er up, please."