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It probably comes as no surprise that the price of a share of stock in an oil company is closely tied to the price of a barrel of oil itself. For example, at the end of 1998, Occidental Petroleum (symbol OXY) traded at $6.47 a share, adjusted for splits. At the beginning of July, Oxy was at $59 -- roughly a ninefold increase. Over the same period, the global average price of crude oil, according to the Energy Information Administration, rose from $9.48 to $68, which means roughly a sevenfold increase.
Upside advantage
Occidental makes most of its money in oil exploration and production, or E&P. In energy jargon, it is mainly an upstream business. A company such as ExxonMobil, by contrast, has substantial upstream and downstream operations. As an integrated firm, Exxon extracts oil, distributes it through tankers and pipelines, refines it, and sells it to businesses and the public.
As a result, Exxon, BP, Shell and other integrated companies benefit less than E&P firms when oil prices soar. The upstream side of the business does well, but downstream, high oil prices raise costs for wholesalers and dampen demand by consumers. Ultimately, stock prices reflect this. Since 1998, Exxon shares have little more than doubled. BP stock has gone from $45 to $74.
Of course, if you own shares in an integrated oil company, you get a relatively smooth ride. According to Value Line Investment Survey, Exxon, BP, Chevron and most other integrated firms are less volatile than the market as a whole. Such stocks also pay nice dividends. Since 1991, Chevron's dividend has gone from 81 cents to $2.32 a share, rising every year. So if you're looking for stability, buy big integrated oil. But if you believe energy prices will stay high, then the place to be is exploration and production.
As E&P stocks go, Oxy is pretty tame. Parallel Petroleum (PLLL) has risen 15-fold since the depths of the late 1990s. Chesapeake Energy (CHK) has soared from less than a dollar at the end of 1998 to more than $35 in mid 2007.
But investors care about the future, not the past. E&P shares have risen with the prices of oil and natural gas (I'll get to that later), as well as with increased efficiency and greater unit sales. But will prices remain at their current levels, or perhaps even increase?
Yes, says Wayne Andrews, a managing director at Raymond James & Associates, who has a sparkling record as an analyst. In a report issued in early July, he and his colleagues say they are "thoroughly bullish on both oil and gas long term." Andrews forecasts $70 a barrel for oil at the end of 2008. He ranks Occidental, which gets 78% of its revenues from producing crude oil, a strong buy. Ditto Parallel and Bois d'Arc Energy (BDE), both much smaller companies with market caps of about $1 billion. He also gives a top rating to EV Energy Partners (EVEP), which trades as a limited partnership on Nasdaq.
Andrews's reasoning is straightforward. First, OPEC, the 11-nation oil cartel that is responsible for about two-fifths of the world's oil production and two-thirds of its proven reserves, "has conviction to support a $60 oil price," which provides a reassuring floor for investors. OPEC alone can't determine prices; it was helpless in the face of past sharp declines, not only in the late 1990s but also during the recessions of 1991 and 2001. Still, OPEC members no longer believe that prices in the $60 range will slow global growth, and intentionally or not, their production has been falling. Non-OPEC oil production is also slowing considerably; Mexico's peaked in 2004, Russia's in 2003.
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