Should investors still get fired up about oil stocks?

When oil prices declined recently – and only briefly – some analysts believed that oil stocks would soon cease being worth getting fired up about. That was then, this is now – and crude oil prices continue to rise. This has, of course, boosted the shares of companies in the oil sector, which is still outperforming broader markets.

Given the continued strength of the oil sector and the robust performance of oil stocks, investors must raise the following question: how much upside potential does the group have left? Should investors expect the same level of momentum in the coming months? Are oil stocks worth investing in now? The best way to answer these questions is to look at the prospects of the sector’s sub-industries individually.

The investment outlook for integrated oil and gas stocks is positive as a result of these factors:

• Recent restructuring programs
• Focus on long-term projects offering growth at a optimal cost
• High oil and gas prices (therefore, higher revenues)
• Global diversification (which will likely help mitigate any economic and geopolitical risks)

The investment outlook for refining stocks is also positive for these reasons:

• A favourable demand-supply profile
• Possibility of significant feedstock discounts (with the greater emphasis on lower-quality crudes)

In addition, the investment outlook for drilling stocks is also positive due to favourable industry fundamentals:

• Prospect of higher capital spending
• A significant rise in rig activity
• Accelerating rates (called dayrates) for providing and operating drilling equipment (in light of very scarce equipment)
• Higher dayrates for jackup rigs
• Improving markets for semi-submersible rigs

The investment outlook for exploration and production stocks is slightly positive. Here’s why:

• On the negative front are concerns about supply, given the possibility of disruptions due to problems in the Middle East, Russia, and Nigeria.
• On the positive side is the prospect of greater demand, leading to steadily rising oil prices and, in turn, potentially superior returns on capital.

Stephen Carlin, manager of Talvest Global Resource Fund, also believes that the oil sector has a favourable outlook: "Given the attractive outlook for oil prices, I believe that the oil sector, relative to other groups, continues to offer the most upside potential."

Some of the stocks that fall into this group include the following: Archer-Daniels-Midland, BP, Canadian Natural Resources, ChevronTexaco, ConocoPhillips, Devon Energy, EnCana, Exxon Mobil, Nexen, Petro-Canada, PetroKazakhstan, Suncor Energy, Talisman and Valero Energy.

April 2005

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.