Why Energy Stocks Could Burn Out

Barring a catastrophe, oil and gas prices may peak soon, which could be bad news for investors who have bid up the shares

Prices for crude oil and gasoline are surging. Crude has climbed above $25 a barrel for the first time since September 11, and gas prices rose 14 cents during two weeks in March alone, according to the latest Lundberg Survey of 8,000 gas stations nationwide. That's the largest 14-day per-gallon increase since the survey began 50 years ago. The average national price for a gallon of regular unleaded is $1.34, according to the American Automobile Assn.

Not surprisingly, shares of some oil companies have been racking up gains. Oil-field supplier Schlumberger (SLB ) is trading at $56 a share, up 40% since its 52-week low of $40 last September. Baker Hughes (BHI ) is around $37, a 48% gain over its yearly low of $25 in September. Both companies offer products and services related to oil exploration.

The stocks of some integrated giants that find and drill for oil and churn out refined products also have been rising. ExxonMobil (XOM ) is at $43, within shooting distance of its yearly high of $45 last June. And BP (BP ) is changing hands at $51, near its 52-week high of $55 last April. Refiners also have been rising, with Valero (VLO ) at $47 a share, near its yearly high of $52 last May.


  Time to buy? Not so fast. Before potential investors dive into the oil patch, they should know that some analysts believe the recent run-up in oil prices and related stocks is too much, too fast, and not sustainable. The bulls are thinking that the economy will gain steam in the second half of the year and subsequently lift demand for crude. However, oil prices usually move ahead of expected trends, and an uptick in the economy already has been priced into current oil prices, some analysts say.

Michael Young, an oil analyst at Gerard Klauer Mattison, estimates both commodity and oil prices could correct by 10% to 20% during the next six months. Adds Gary Russell, an oil-field-services analyst and vice-president of the energy group at Frost Securities: "I think the upside potential for commodity prices from here over the next seven to nine months is probably going to be limited."

Meanwhile, retail gasoline prices are expected to climb further by summer -- but probably not reach the levels seen a year ago, when the economy was booming and energy demand was sky-high. Barring a fire or other unexpected problems at a major refinery, gasoline prices this summer probably will stay below the peaks of around $1.70 a gallon hit in 2001 and the previous year, says Douglas MacIntyre, senior oil market analyst at the Energy Information Administration (EIA), the Energy Dept.'s statistical arm. A year ago, areas around Chicago even saw gas selling for $2 to $2.50 a gallon following the rupture of a major pipeline that served the region.


  Crude oil and gas prices are surging now largely because of tight supplies and because pump prices were so low recently. As the global economy slowed after September 11, demand for crude retreated, and the price per barrel slipped to around $20. By the New Year, lower crude prices reached gas stations, which were selling regular unleaded for an average of a buck a gallon. That's when OPEC intervened, hoping to prop up crude prices.

In December, the oil cartel agreed to cut production quotas by 1.5 million barrels a day, to 21.7 million, starting in January. Non-OPEC oil-producing countries also scaled back production, resulting in less oil sloshing around the market. The cutbacks eventually led to tighter crude supplies, and the rise in gasoline prices to their current levels began in February.

The national average for a gallon of regular unleaded increased 19% -- or 22 cents -- in the past month, to $1.34, according to the AAA. Gasoline demand has been getting a boost from consumers who have opted to drive rather than fly, prompted either by fear or to avoid lengthy, security-related check-ins at airports.


  Of course, there's one big wild card: Escalating tensions in the Middle East. All bets are off if hostilities between Israel and the Palestinians grow into a broader regional conflict, or if the U.S. attacks Iraqi strongman Saddam Hussen. Iraq is among the world's top-10 oil-producing nations and a key member of the 11-nation OPEC cartel. Any such instability in the region could trigger supply disruptions, which would mean spikes in oil prices.

However, Patti Harper-Slaboszewicz, an energy expert for consultancy Frost & Sullivan, notes that while any glitch in oil supplies in the politically tense region would send crude prices higher, they could eventually settle down after other exporters like Russia and Venezuela made up for the slack.

Current stockpiles suggest there's enough oil in the bank to act as a buffer against a possible supply disruption in the Middle East. As of mid-March, crude inventory levels were up 13% compared with year-ago levels and 5.5% above the five-year average, according to EIA data. "That means there's still plenty available," says MacIntyre.

Barring unexpected catastrophe, consumers could be smiling again soon. Investors, though, may want to hold off on oil shares until it's clearer that global crude demand is gaining solid momentum.

By Heesun Wee in New York

Edited by Thane Peterson

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