Power from Energy

Some oil stocks are set to pump back up in 2003.

Crude-oil prices have climbed 50% in the past year as the specter of war with Iraq and political unrest in Venezuela continues to haunt the market. Yet oil-company shares have gone the other way: Evidently the market doesn't seem to think prices of $30 a barrel are sustainable. As a result, the average international oil-company stock has fallen about 11% in 2002.

Those diverging trends--oil prices up, stocks down--create an opportunity to pick up quality issues at bargain prices. L. Bruce Lanni, an energy analyst at A.G. Edwards & Sons Inc., thinks oil prices won't drop much--to an average of $25 a barrel next year--because of strengthening world economies and production restraint on the part of OPEC. If that's the case, energy-company stocks could do quite well in 2003.

Lanni's top pick is Royal Dutch Petroleum (RD ), whose shares have dropped 11% this year. Much of that decline is based on an event beyond the company's control: Royal Dutch was removed from the Standard & Poor's 500-stock index in July--along with all other companies headquartered outside the U.S. That change forced index funds to dump the stock. Royal Dutch has plenty going for it, says Lanni: cost-cutting and the divestiture of lower-returning assets. He figures that earnings will climb 15% next year, to $3.05 a share.

Another familiar name going cheap is Unocal Corp. (UCL ), a Los Angeles oil-and-gas producer. At $31.36, the stock is down from nearly $40 in April. J.P. Morgan Chase & Co. oil analyst Shannon Nome--whose firm has done investment banking for Unocal--thinks the sell-off is overdone. She says Unocal is trading at a 20% discount to its peers, based on her projection of the 2003 cash flow. Nome figures Unocal's production of oil and gasoline will climb about 3% annually in the coming three years. "Virtually every other analyst is negative on Unocal," Nome says. "But the company's lineup of projects still looks good."

In 2002, stocks of oil-field suppliers held up better than those of producers, but Banc of America Securities analyst Jim Wicklund still sees opportunities. In particular, he likes Smith International (SII ), which provides drill bits and fluids. Wicklund notes that several U.S. natural-gas producers that cut drilling in 2002 will step it up in the new year, boosting the profits of companies like Smith.

In the battered power industry, Dominion Resources Inc. (D ) in Richmond, Va., looks poised to prosper. The company supplies electricity and gas to 3.8 million customers in five states. To strengthen its finances, Dominion has sold stock and reduced capital expenditures. It has no major international or energy trading operations, sources of trouble for others. Dominion also has sizable oil and gas businesses that should benefit if gas prices remain strong.

The electricity market still shock you? Frederick Sturm, portfolio manager of the $30 million Ivy Global Natural Resources fund, suggests Peabody Energy (BTU ), the world's largest coal producer. He sees earnings up 50% next year, to $1.70 a share, thanks to rising coal prices and higher demand for electricity brought on by a strengthening economy.

O.K., coal doesn't sound like an exciting investment. But it can be a solid one. Even in the 21st century, half the electricity generated in the U.S. comes from coal.

By Christopher Palmeri

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