A Cushion for Oil-Price Shock

Investing in a few energy stocks or mutual funds can help offset the risk to your portfolio of a wider war in the Mideast or Asia

Among the many things I don't know: where stocks, interest rates, and the dollar are headed. Also, the future price of oil. One thing I do know: Each day's news makes me more worried about a wider war in the Mideast or Asia. War, and the risk that it will make oil more costly, are dangers to most portfolios--but ones that too few investors are protecting against.

Numbers tell me this is true. Twenty years ago, when energy stocks were hot, they made up more than 16% of the value of the Standard & Poor's 500-stock index and 5 of the top 10. Now, they're down to 7%, and just one, ExxonMobil, is in the top 10. Investors are so skeptical of energy companies that when the ordinarily contrarian researchers at Morningstar last year drew up a list of 50 stocks to buy (at the right price), not one energy name made it.

You also can see investor apathy toward energy in the news--or, rather, in what's not news. Take a recent example about Schlumberger (SLB ), the oil-services giant. Twenty years back, it was a glamour stock, a Cisco Systems (CSCO ) of the oil field whose CEO became the subject of a long, loving profile in The New Yorker. Now, not even The Wall Street Journal found room for a brief mention of Schlumberger's May 21 announcement that it will spin off a technology unit.

So I set out to shop for some oil insurance--that is, energy investments to protect a portfolio against higher oil prices. As with auto or home insurance, I wasn't looking for big potential gains. In fact, I would hope not to have to make a "claim" on this "policy." Nor did I look for the cheapest quote. With insurance, that can prove foolish if the discount underwriter collapses beneath a ton of claims. I just wanted financially strong stocks that would rise with oil prices.

Using Value Line's software, I searched for energy issues with market values of at least $5 billion and total debt of no more than one-third of capital. I asked, too, for positive free cash flow and a dividend yield of at least 2%, a bit more than an average stock or money-market fund now pays.

The result? Just three stocks. One, Halliburton (HAL ), I cut because of peculiar risks: It's coping with asbestos liabilities, while regulators are investigating its accounting. That left BP (BP and ExxonMobil (XOM ). Next, I checked how each stock moved over six trading days in mid-May, when oil prices jumped above $29 a barrel from near $26. Both stocks gained about 4%. Finally, for a different perspective, I spoke with Standard & Poor's oil analyst Tina Vital. Between BP and ExxonMobil, she favors Exxon as the more credible operator. "It has always delivered on its promises" of production growth, she told me.

Buying just one or two stocks doesn't suit many people, however. So, in search of a diversified hedge against higher oil prices, I also set out to shop for mutual funds. Again, I wasn't looking for big capital gains that an active manager would hope to produce. So I focused on exchange-traded funds that replicate energy-stock indexes. I found three possibilities (table). Based on cost, Energy Select Sector SPDR Fund looks like a good choice. At a recent price of $26.50 a share, it yields 1.4%.

If you think oil is going up, there are more aggressive ways to speculate. Veteran energy analyst Charley Maxwell of Weeden & Co., whose forecast last fall of higher oil prices this spring proved correct, favors North American producers with assets in Canada's Athabasca tar sands. Among them: Suncor Energy (SU ) and Imperial Oil (IMO ). If, however, the future of oil is on your list of unknowables, yet you find it has become a persistent worry, try giving your portfolio some oil insurance instead.

By Robert Barker

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