A Comeback for the Oil Patch?

Some managers see prices bouncing back

Remember the energy crisis? Just a few months ago it seemed the world was running out of fuel. Now, energy trading juggernaut Enron Corp. (ENE ) is bankrupt, gasoline sells for under $1 a gallon in many markets, and a barrel of crude trades for $19, down 40% from a year ago. It sounds like a better time to buy a gas-guzzling SUV than Exxon Mobil Corp. (XOM ) stock.

But some money managers say energy is the place to be in 2002. That's because recent declines in commodity prices are already reflected in energy stocks: Those in the Standard & Poor's 500-stock index are down an average of 17.9% since the start of 2001. "We recognize that current earnings are not good, but we think prices have bottomed," James P. Coughlin, manager of the $250 million Enterprise Growth & Income Fund. "The economy is not falling off a cliff. Supply and demand will come into balance."

Energy now makes up 14% of Coughlin's fund assets, vs. 6% for the S&P 500, according to fund tracker Lipper Inc. Coughlin's move is part of a broader strategy to take advantage of the U.S. economic recovery he believes is coming in 2002. For now, he's sticking with conservative names such as Exxon Mobil, Royal Dutch/Shell Group (RD ), ChevronTexaco (CVX ), and BP (BP ). The companies are trading at steep discounts to the market and generating much higher dividend yields. BP, for example, is considered one of the best managed oil companies. It trades at just 15.7 times anticipated 2002 earnings, vs. 21.5 for the overall market. BP yields 3%, three times the market average. "The group has been out of favor," Coughlin says. "We like to buy cheap."

Mark Regan, manager of the $1.8 billion MFS MidCap Growth Fund, also believes prices will bounce back, but he is focusing on the U.S. natural gas market. When gas hit $10 per million British thermal units in late 2000, a lot of power plants and businesses switched to other fuels. With the price much lower now, Regan believes demand will come back. Meanwhile, new supply has been much tougher to find.

Regan has large positions in companies such as Devon Energy (DVN ), Apache (APA ), EOG Resources (EOG ), and Newfield Exploration (NFX ). But he has been selling drilling rig operators such as Global Marine (GLM ), Transocean Sedco Forex (RIG ), and Diamond Offshore Drilling (DO ) because he thinks the current price of natural gas--around $2.50 per million BTUs--is discouraging companies from doing any drilling. "Rates for rigs will come down," Regan says. "The price of gas will come back first."

What if energy prices don't bounce back? James W. Stratton, manager of the $50 million Stratton Growth Fund, is betting on refiners. "As the price of crude falls, refined products fall as well, but not by as much," Stratton notes. "They benefit from the spread." Stratton likes that refiners like Ultramar Diamond Shamrock Inc. (UDS ), which is in the process of merging with Valero Energy Corp. (VLO ), have been buying back their own shares rather than investing in new capacity. Stratton also owns USX Marathon Oil Corp., which will be spun off from USX Corp. (X ) on Jan. 1. Stratton thinks Marathon's strong exploration and refining businesses make it a takeover candidate. "My sense is they won't stay independent long," he says.

The beleaguered energy-trading industry is also ripe for consolidation, says Raymond James & Associates energy analyst Fred Schultz. Larger, more diversified companies such as Duke Energy (DUK ) and El Paso Energy (EPN ) could acquire the likes of Mirant (MIR ). "Anyone with natural gas assets will be looking for power assets," he says. But whether you are an acquisition-minded CEO or just an investor, the best time to go shopping in the energy sector is when prices are low.

By Christopher Palmeri

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