Second-Half Outlook: Energy

Geopolitical concerns could cause short-term stock-price fluctuations, which will give patient investors a chance to buy on the downturn

Energy stocks ended the first half with such a bang that investors should be cautious placing bets in the second half. Thanks to a flurry of oil patch deals, culminating with Anadarko's $21 billion double-play to buy Kerr-McGee (KMG) and Western Resources, and to the price of oil once again topping $70 per barrel, the sector regained a lot of the ground lost earlier in the second quarter.

Many stocks approached their 12-month highs on June 30. So investors should be patient and wait for another major pullback (there have been a half dozen since the bull market in energy stocks launched in 2003) or pick stocks with absolutely rock-solid fundamentals.

The integrated companies such as Conoco-Phillips (COP), Total (TOT) and Chevron (CVX) are still selling at reasonable single-digit price-earnings multiples and probably represent the safest plays. Their stocks tend to be less volatile than smaller or specialized companies, and they pay out fat dividends.


 Service companies such as Schlumberger (SLB), drillers like Transocean (RIG) and Noble (NE), and equipment makers like Baker Hughes (BHI) also have good long-term prospects because of the huge buildups in their order books. Their exploration-company customers have gotten more confident that high oil and gas prices could last for at least the rest of the decade, and they are making huge new commitments for projects that will take 5 to 10 years to complete.

Equity analysts at Standard & Poor's are also high on utilities Duke Energy (DUK) and FPL Group (FPL), which are benefiting from a tight U.S. power market.

With such big moves in the past couple of years and so much geopolitical turmoil, energy stocks will no doubt continue to fluctuate wildly in the coming months. But as long as global economies remain strong—particularly in developing countries such as China, Russia, and India that are pushing up demand—the energy stocks are likely to outperform many other sectors in the long term. Investors will do well if they are disciplined in timing purchases and are brave enough to handle the wild ride.

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