When crude oil prices are high and demand is strong, those infamous "obscene profits" of the major oil companies are unleashed once again.
The question for stocsk investors is how they feel about trying to benefit from this trend rather than complaining about it.
ExxonMobil Corp. recently reported its net income rose 27 percent to $8.42 billion in the fourth quarter of 2004. That was not only the largest quarterly profit in the firm's history, but a record for any U.S. public company.
Meanwhile, ChevronTexaco's net income rose 98 percent in the quarter to $3.4 billion, and ConocoPhillips net income more than doubled to $2.4 billion. Other industry results were similarly dramatic.
The energy industry has always evoked strong emotions. The Rockefellers, Gettys and OPEC members were all labeled villains. The entertainment industry poked fun at nasty oil mogul J.R. Ewing of TV's "Dallas" and clueless oil millionaire Jed Clampett of "The Beverly Hillbillies."
It's all because of the big money involved, the constantly changing world events that affect prices, and the angst that higher prices cause consumers.
"Every time a suicide bomber takes something out in Iraq, it causes the price of oil to fluctuate, so in the next six months you will see dramatic price changes in oil, depending on the political stability in countries such as Iraq and Russia," acknowledged Malcolm Polley, chief investment officer for S&T Wealth Management Group in Indiana, Pa. "But in the long term, prices will remain high and go higher."
Crude oil prices slipped recently after OPEC ministers decided to leave production quotas unchanged and took no steps to stop Saudi Arabia from producing over its level. The surprisingly strong vote turnout in Iraq was also promising for the oil supply.
On the other hand, major oil companies are encountering supply problems as they attempt to replace the oil they've sold. Demand from China is a wild card, and in terms of real turmoil, worker demonstrations at the ChevronTexaco Corp. terminal in Lagos, Nigeria, left several dead recently.
"This is absolutely a good time to invest in the oil stocks because they have a huge upside from current levels," asserted Sheraz Mian, senior oil analyst with Zacks Investment Research in Chicago, who notes that the general estimate for crude oil is an average of $40 a barrel during 2005-2006.
However, investors must take a long-term perspective because the serious issues affecting the oil industry won't play out in three to six months, Mian added.
"The strong voter turnout in Iraq should allow for additional investment and production there," predicted Dan Denbow, portfolio manager and equity analyst for USAA's Private Investment Management in San Antonio, who thinks crude oil is pushing toward $50 a barrel. "It will help service companies doing the work, but in the long run the entire industry will benefit."
Denbow likes oil services companies because of increased drilling activity, a fixed supply of drilling rigs to meet demand and rapidly rising day rates.
"Over the next several years, there will be stronger growth in the oil companies, which generate a ton of cash and want to give it back to shareholders," said Tim Parker, an exploration, production and oil services analyst with T. Rowe Price in Baltimore. "In oil services there's more cash on the books after paying dividends, and they are throwing that money back into the ground to drill."
At the pump this summer driving season, Mian expects prices for regular gasoline at $2.10 to $2.20 a gallon, Polley predicts $2 a gallon and Parker expects $1.80.
Some stocks offer opportunities.
ChevronTexaco (CVX), which benefits the most from oil prices because 70 percent of its total production is oil, is recommended by Denbow and Mian. It has done an excellent job of turning itself around by selling U.S. exploration properties and acquiring them in other countries. Its refining business is strong on the West Coast of the United States and in Asia. ChevronTexaco has an excellent balance sheet with an excess of $10 billion. Besides crude oil, it is in chemicals, coal mining and natural gas.
ConocoPhillips (COP), selling at a discount and hoping to become a "super major" oil company, is recommended by Denbow and Mian. The largest oil refiner in the United States has become more aggressive to improve its return and balance sheet so that Wall Street affords it more respect. It beat out ChevronTexaco to purchase a 10 percent stake in Lukoil, largest oil producer in the Russian market. ConocoPhillips is also significant in natural gas, natural gas liquids, petrochemicals and plastics.
ExxonMobil (XOM), with the best return on investment in the industry, is owned by Denbow and recommended by Polley. It is able to increase its production by 2 percent and replace its reserves by 100 percent each year, maintaining growth and revenues. ExxonMobil is also in petrochemicals and electric power generation.
In addition, among the oil companies, Denbow recommends the stock of BP Plc. (BP), Polley recommends Royal Dutch Petroleum Co. (RD), Mian recommends Amerada Hess Corp. (AHC), and Parker recommends Murphy Oil Corp. (MUR). In exploration, Polley recommends Devon Energy Corp. (DVN) and Pogo Producing Co. (PPP). In oil services, Parker's favorite is Schlumberger Ltd. (SLB).
Editor's Note: Andrew Leckey is a regular contributor to The Bull & Bear Financial Report.
