Energy Stocks Hold Up Even as Oil Prices Drop
Oil prices tumbled again Thursday, as the emergency meeting OPEC had planned for next week appeared unlikely to occur because of renewed bickering among cartel members.
Yet the latest decline in crude prices failed to rattle major U.S. energy company stocks, most of which closed unchanged or slightly higher despite sharp losses elsewhere on Wall Street.
A flurry of surprisingly good earnings reports from some energy giants--including Amoco Corp., Texaco Inc. and Occidental Petroleum--helped to buoy the group Thursday. But some experts say investors’ reluctance to part with the stocks may signal something more significant: A fear of renewed inflation, and thus the need to own a hedge.
Other analysts admit they aren’t quite sure how to explain energy stocks’ resilience in recent weeks, as crude prices have slumped. “I’ve been surprised and confounded,” says William Randol, analyst at Salomon Bros. in New York.
On Thursday, light, sweet crude oil futures for September delivery closed at $17.63 a barrel in New York, down 30 cents for the day. Since early May, the price has tumbled about 15%, from just under $21.
Yet Exxon Corp. stock, unchanged Thursday at $64.125, has fallen only 7% from its recent peak of $69. Chevron Corp. closed at $86.50, unchanged and off just 5% from its peak. Even Amoco, weaker than most, is down 11% from its high, but added 12.5 cents to $52.75 Thursday.
Traditionally, investors abandon energy stocks whenever an oil supply glut develops and the price of crude begins to slide. In recent weeks, supply worries have ballooned as Iraq and the United Nations have entered serious negotiations for Iraq’s re-entry into the market for the first time since its defeat in the 1991 Gulf War.
With new Iraqi sales looming, OPEC is in disarray over how to shore up oil’s price, which already is weak because of the sluggish world economy. Unquestionably, somebody will have to cut production.
But Thursday, Iran called for Saudi Arabia to cut, while the Saudis balked. In something of an understatement, OPEC President Jean Ping said key cartel members aren’t ready to meet, and would probably wait until mid-August, assuming the U.N. and Iraq reach an agreement by then. That raises the prospect of a much steeper slide in crude prices ahead.
So why aren’t the energy stocks plummeting? For now, the fundamentals underpinning the stocks appear too favorable for investors to ignore:
*Solid first-half earnings. Many of the energy companies reporting second-quarter earnings on Thursday topped analysts’ estimates--in some cases by a substantial margin. Amoco, for example, reported a 128% rise in operating earnings, to 98 cents a share from 43 cents a year ago. Analysts had expected about 80 cents.
Texaco also had a good quarter, earning $1.10 a share from operations, up 124% from a year ago. Even Occidental Petroleum--a perennial Wall Street whipping boy--had a winning quarter, earning 21 cents a share from operations, up 17% despite flat revenue. Oxy stock rose 62.5 cents to $21.375 on the news.
Most of the energy giants said results were boosted by deep cost cutting over the past year. “I am especially pleased that our ongoing cost-reduction efforts are making a difference on the bottom line,” crowed H. Laurance Fuller, Amoco’s CEO.
Lower interest costs also helped. But for most of the companies, another factor was more important:
*High natural-gas prices. While oil prices have dropped since spring, natural-gas prices have held up remarkably well, around $2 per thousand cubic feet. Because many “oil” companies actually derive more of their earnings from gas, their results are rising despite oil’s slide.
After nearly a decade of glut, natural-gas supply and demand in North America appear to finally be in sync. In fact, some pros argue that production has been cut back so severely since 1990 that the odds favor tight supplies for years to come.
Dan Rice, manager of the Met Life/State Street Global Energy stock mutual fund in Boston, says Canada alone should have drilled 3,000 new gas wells in 1992 to its maintain deliverable inventory. Only about 1,000 were drilled.
While higher gas prices were expected to spark a renaissance in U.S. drilling, Rice says that so far this year, “The drilling recovery is much slower than expected.” Hence, demand is sopping up all available supply, and prices are holding--producing a windfall for energy firms.
Occidental said its second-quarter operating earnings of $75 million from oil and gas, up from $44 million a year ago, “primarily reflected higher domestic natural-gas prices.”
The stocks’ dividend yields. Many large energy companies boast dividend yields that are almost twice what investors can earn in money market funds. Exxon, for example, pays an annual dividend of $2.88 a share, giving it a yield of 4.5%.
Institutional and individual investors alike are unwilling to give up those yields simply because of what they perceive as a temporary slump in oil prices, some analysts say.
Michael Mayer, analyst at Wertheim Schroder & Co. in New York, says that when he has suggested that clients lighten up on energy stocks over the past month, “They say, ‘Where else do I put my money and pick up nearly 5% yield?’ ”
Still, Mayer believes that oil prices are going lower before they rebound, and he contends that the stocks will respond to that drop. He sees another 5% to 10% decline in the shares.
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Yet for buy-and-hold investors who view energy stocks as an important piece of a portfolio in the ‘90s, even the prospect of a 10% decline may not be enough to warrant selling. The big question is, are the companies’ long-term earnings prospects still decent?
Until this year, the stocks had gotten little real lift in the ‘90s. Their gains this year were partly in anticipation of higher earnings from restructurings and from natural gas--both of which are coming through. Ultimately, though, the energy companies need higher oil prices as well to guarantee longer-term growth, which means OPEC will have to compromise yet again and rein in production.
The other side of the equation, of course, is demand. If the world economy picks up steam in the next few years, some analysts believe oil could go from relative oversupply to relative shortage in a hurry. Natural gas is already there.
Logically, a tighter supply/demand situation for oil would probably be part of a broader resurgence in inflation. Viewed in that context, many investors may be treating energy as a longer-term hedge--in the same way that gold has come back into favor, suggesting that higher inflation is over the horizon.
Tracking Energy Stocks
Most major energy stocks still are close to their 52-week highs, despite the plunge in oil prices. Analysts say the stocks are holding up in part because of their generous dividend yields.
52-week Thurs. Div. Stock high/low close yld. Amoco 59 1/4-46 3/4 52 3/4 4.2% Atl. Rich. 127 3/4-105 5/8 114 1/2 4.8% Chevron 90 7/8-66 5/8 86 1/2 4.0% Exxon 69-57 3/4 64 1/8 4.5% Kerr-McGee 53 1/4-38 3/4 51 5/8 2.9% Louisana Land 47 7/8-31 45 7/8 2.2% Mobil 75 7/8-59 69 3/4 4.6% Occidental 23 1/2-15 3/4 21 3/8 4.7% Phillips Pet. 32 1/4-23 1/8 28 3/4 3.9% Royal Dutch 94 1/2-78 3/4 92 1/8 4.5% Sun Co. 30 1/4-22 1/4 25 7/8 7.0% Unocal 32 5/8-22 1/2 28 3/8 2.5%
