New Energy for Oil and Gas Stocks

S&P sees the group benefiting from rebounding world economies and rising demand, while supplies start to slip

By Sam Stovall

Energy prices are once more on the rise, and it comes as no surprise that shares of companies that search for and produce oil and natural gas have outperformed the overall market in 2002. Year-to-date through Dec. 12, the S&P Oil & Gas Exploration & Production (E&P) Index was up 3.5%, compared with a 21.7% decline for the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600). The gains have powered the group into the list of industries with top Standard & Poor's .

S&P analyst John Kartsonas believes the E&P group will continue to outperform the broader market in the next 9 to 12 months, especially as declining production and climbing demand support stronger natural-gas prices. He's upbeat about both the near- and longer-term outlook for the E&P sector.


  Kartsonas notes that these stocks usually trade in tandem with commodity prices. However, the E&P group was recently trading below the 2002 peak that it reached in spring, although natural-gas prices are at 52-week highs, and oil prices remain around $30 per barrel. Economic forecasting outfit Global Insight expects U.S. natural-gas prices to average $3.25 per million BTU in 2002 and $3.50 in 2003. (BTU, or British thermal units, is a widely used measure of energy -- one BTU is the amount of heat required to raise one pound of water one degree Fahrenheit.)

As economies worldwide emerge from the doldrums, Global Insight projects that international oil demand will increase over 1% in 2003. Furthermore, experts predict that oil supply will likely slide -- strangely enough, because oil cartel OPEC recently agreed to raise production quotas to 23 million barrels per day, from about 21.7 mbd now. While on the surface it seems that the cartel is letting its members open the spigots wider, the move was really made to limit "quota cheating" (overproduction) by member nations. OPEC's aim is to lower its actual total output to be more in line with official production by giving its constituents a target they can live with.

OPEC historically has targeted a price of $22 to $28 per barrel for its oil "basket" (an average price for the different kind of crudes produced by OPEC members). The OPEC basket was at $28.61 per barrel as of Dec. 17.

Kartsonas says the outlook for natural-gas prices is positive for industry participants for the short and long term. The early arrival of cold weather in the U.S., combined with below-average gas-storage levels and expectations for lower American production, has pushed prices above $5 per million BTU, the highest level in more than one-and-a-half years.

Although the tight supply-demand situation could lead to price spikes this winter, Kartsonas expects prices to average around $4 per million BTU in the intermediate term. According to the Energy Information Administration, the U.S. has 2,794 billion cubic feet of gas in storage as of Dec. 6, 2.48% below the five-year average.


  On the demand side, Global Insight forecasts total natural-gas demand growing by 2.7% in 2003. With U.S. gas-field depletion rates reaching 30% per year and imports limited by infrastructure constraints -- in pipelines as well as vessels and facilities that transport and process liquefied natural gas. Kartsonas believes domestic natural-gas demand will exceed available supply in the future. He says these strong fundamentals should support a healthy environment for E&P outfits.

Kartsonas' current favorites in the group include Apache (APA ), Ocean Energy (OEI ), and EOG Resources (EOG ). S&P ranks them all 5 STARS (buy).

S&P Relative Strength Rankings

These industries carry 12-month relative strength rankings of "5" as of Dec. 13, 2002 -- meaning that they're in the top 10% of the 116 industries in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600) based on prior 12-month price performance.

Industry/Sector Largest Company (Market Cap.) S&P STARS* Rank
Apparel Retail/Consumer Discretionary Chico's FAS (CHS) 5 STARS
Apparel, Accessories & Luxury Goods/Consumer Discretionary Quiksilver (ZQK) 5 STARS
Brewers/Consumer Staples Anheuser-Busch (BUD) 4 STARS
Consumer Electronics/Consumer Discretionary Harman International (HAR) Not Ranked
Distillers & Vintners/Consumer Discretionary Constellation Brands (STZ) 5 STARS
Gold/Materials Newmont Mining (NEM) 4 STARS
Housewares & Specialties/Consumer Discretionary Newell Rubbermaid (NWL) 5 STARS
Metal & Glass Containers/Materials Pactiv (PTV) 5 STARS
Oil & Gas Exploration/Energy Apache (APA) 5 STARS
Photographic Products/Consumer Discretionary Eastman Kodak (EK) 1 STAR
Trucking/Industrials Yellow Corp. (YELL) 5 STARS

*S&P's ranking system for the appreciation potential of stocks over a 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).

Stovall is chief investment strategist for Standard & Poor's

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