There’s Gloom in the Oil Patch, So It’s Time to Buy

Oil stocks are unpopular today, with crude oil prices down in the scary zone around $13 a barrel. That’s why this is a good time to buy.

In saying this, I’m not a disinterested party. My firm has a sizable holding in big oil stocks such as Amoco Corp., Atlantic Richfield Co. and Texaco Inc. We also bought some oil-service companies this year.

While I may not be objective, I believe I’m right. Today’s oil-price weakness isn’t unprecedented. In the past 12 years, there were four other times when oil prices dipped below $15 a barrel. They were the full year of 1986, August through December of 1988, June 1990 and December 1993 through April 1994.

I think that the current spell of price weakness, too, shall pass.

Oil prices were in the range of $20 to $22 a barrel when the Asian economic crisis erupted in October. They fell rapidly and steadily until March, when they dropped below $15. Since then, they have been crisscrossing the $15 line. In the past couple of days, they have crossed the $13 level.

Past periods of price weakness were a great time to buy oil-service stocks and not a bad time to buy the big, integrated oil companies: Exxon Corp., Royal Dutch Petroleum Co., Mobil Corp., Chevron Corp., Amoco and Texaco.

Simmons & Co. International is a small brokerage house in Houston that specializes in oil-service stocks. It looked at the performance of these shares during the 12-month periods following the end of each period of weakness in crude oil prices.

On average, Simmons found, oil-service stocks gained 37% during these snap-back periods. That was 1.8 times the gain in the Standard & Poor’s 500 index, which was 21% on average. In its measurement, Simmons used Schlumberger, Halliburton Co., Baker Hughes Inc. and Global Marine Inc. as proxies for the oil-service group.

Service stocks get clobbered when oil prices are weak because people fear that oil producers will slash their exploration and production budgets.

Buying these stocks on weakness may be a great long-term move, though in today’s climate hardly anyone dares to do it. “It’s not like trying to catch a falling knife. It’s like trying to catch a knife that’s being thrown at you,” said Wesley Maat, an oil-service analyst at Deutsche Bank Securities Inc.

Stocks of the integrated oil companies don’t rally as dramatically, but then these companies are steadier on the downside. Because they refine and market oil products, as well as explore for oil and produce it, the big, integrated companies are only moderately sensitive to the price of oil.

What I like about the biggies is that they would probably be bastions of strength, compared with most stocks, in a market decline. Their dividend yields, while unimpressive by the standards of the past, look large by comparison to today’s puny average of 1.4% on the S&P; 500 stocks. Exxon, for example, yields 2.4%, Mobil 3% and Texaco 3.1%. High-yielding stocks traditionally do better than most in market declines.

In addition, energy stocks tend to move in their own long cycles, which are fairly independent of movements in the major U.S. stock indexes. With stock prices higher by most measures than ever in history--compared with underlying measures of value--lack of correlation to the overall market could be a virtue.

Of course, I wouldn’t be a partisan of energy stocks if I thought oil was going to be selling for less than $15 a barrel for several years. I expect it to rise back into the $17 to $20 trading range that has characterized most of the past decade.

The supply-and-demand picture for oil is better than many people think. You hear a lot of talk about a “glut” of oil or about the world being “awash in oil.” I think those phrases are exaggerations.

You may hear estimates that the world produces 76 million barrels of oil a day and uses only 74 or 75 million. The exact numbers vary with the estimators. But I’d take such pronouncements with a grain of salt.

If that were the case, wouldn’t world inventories of oil be rising dramatically? In a conference call last week, Dan Pickering, director of research at Simmons, said there has been no big buildup. Oil inventories can be measured fairly precisely, he said, and they are up only 66 million barrels in the past four quarters in the major industrial countries. That’s far less than the volume that should be accumulating according to many supply-and-demand estimates. Pickering suspects that those estimates are too gloomy.

You hear that anticipated weak demand from Asia explains the big decline in oil prices since October. Really? Asia and the Pacific region (including Japan and China) use about 20 million barrels a day, or about 27% of the world’s total. So if Asian demand fell 10%, it would nick total demand by 2.7%.

Does that explain a 30% drop in oil prices? Only when you stir in a large dose of investor psychology.

Many of the things people use oil for--home heating and power generation, for example--are not highly discretionary. The fact is, most people will give up the country club, the new suit or the new computer long before they will choose to keep their house chilly. They may drive less--fewer vacations, for example--and therefore use less gasoline. But much of their driving is for commuting or necessary errands and won’t be cut back.

As for supply, the once-feared Organization of Petroleum Exporting Countries is now regarded as a toothless tiger. I think people may be underestimating OPEC’s power today, just as they greatly overestimated it 20 years ago.

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John Dorfman, a Boston-based money manager with Dreman Value Management in Red Bank, N.J., writes regularly for Bloomberg News. The opinions expressed are his and don’t represent those of Bloomberg News. His firm or its clients may own or trade investments discussed in this column.

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Cheap Oil

Crude oil futures fell 5% to its lowest level in almost a decade Thursday, on expectations that recent output cuts pledged by exporting nations will not be enough to overcome a worldwide glut. Generic oil futures, monthly closes and latest:

Thursday close: $12.75

Source: Bloomberg News