Doubts Linger Over Energy Stocks Even as Oil Prices Rise

By TOM PERRUNO

Sept. 17, 2000 12 AM PT

Investing in commodity businesses has mostly been a loser’s game for the last 20 years. At best, we could say it has been a trader’s game, with the tacit understanding that most people don’t trade well.

But with oil now near $36 a barrel, commodity investing--or at least, energy investing--is attracting a much broader audience on Wall Street.

The willingness of that audience to hang on to suddenly hot stocks in such industries as oil, natural gas and electricity generation, however, still is a matter of great debate. And any suggestion that people might consider trading some of their Intel or Sun Microsystems shares for a long-term investment in Exxon Mobil or Anadarko Petroleum would probably be met with guffaws or worse.

Substitute a commodity business for a true value-added business? Since when?

That skepticism is understandable, but it also may help the case of those who believe the energy rally has staying power: Every investor who still doesn’t believe--and there are plenty of them--is another investor who may yet be convinced.

On Friday, Exxon, Anadarko and most other energy stocks managed to win over at least a few more people, adding to what has been a tremendous 2000 rally for many of the shares.

Anadarko soared $2.11 to $66.50, for a year-to-date gain of 95%. Exxon rose as high as $89.88 Friday, a record, though its gain for the year is less than 10%--a figure that reflects Wall Street’s deep-seated doubts about many of these stocks.

Supply-constricted oil and natural-gas markets hardly needed another catalyst for a rally, but they got one anyway on Friday in the person of Saddam Hussein: The Iraqi dictator gave the world an unwanted case of deja vu by threatening neighbor Kuwait over oil-rights issues.

In New York, near-term crude oil futures soared $1.85 to close at a fresh 10-year high of $35.92 a barrel.

Natural-gas futures prices, which have already more than doubled this year, hit a record high.

A year ago, crude oil futures were around $25 a barrel. Two years ago, the price was about $16 a barrel.

There’s no argument on Wall Street that higher energy prices are translating into higher profits for companies that explore for, produce, refine and sell oil and gas.

Consider Exxon Mobil’s situation: The company is expected to earn $4.14 a share this year, the consensus earnings estimate of analysts surveyed by Zacks Investment Research.

In the last month alone that estimate has risen by 13 cents a share.

If the $4.14 figure is accurate, it will mean Exxon Mobil--and thus its shareholders--will enjoy earnings this year up more than 80% from last year’s level.

Some smaller energy companies are expected to see even greater profit windfalls. Raymond Plank, chief executive of Apache Corp., a Houston-based oil and natural-gas exploration and production firm, earlier this month told industry analysts that their 2000 earnings estimates were far too low.

While analysts currently figure the company will earn $4.67 a share, according to Zacks, Plank said he expects Apache to bring in about $5.50 a share, up from $1.72 in 1999 and a loss of $1.34 a share in 1998.

Apache stock has had a terrific run this year, lifting the price 77% since Jan. 1. Still, at the stock’s closing price Friday of $65.50 on the NYSE, the shares are valued at about 12 times estimated 2000 earnings per share. That’s less than half the price-to-earnings multiple of the blue-chip Standard & Poor’s 500 index.

Apache’s P/E looks cheap, but that is the cold reality for stocks of most commodity-based companies: The market doesn’t pay up for these stocks, relative to earnings, because there is usually little faith that strong earnings growth can be sustained.

That is largely why, even though the fundamentals pushing this energy price surge have frightening overtones of the prolonged 1970s energy crisis, many investors view energy stocks with a jaundiced eye.

Consider: Many of the stocks, while up in price this year, remain below their peaks reached in the 1990s. That means many investors who have been in the stocks for years still have made no significant capital gain, if any--even with the rally this year.

If you believed in Unocal Corp.’s overseas natural-gas exploration strategy in early-1997 and bought the stock at around $38 a share at that point, you’ve lost money so far: The stock, though up 12% this year, was at $37.56 on the New York Stock Exchange at Friday’s close.

If instead you’d bought Intel shares in early 1997 at around $18 a share, you’ve made about 220% on your investment.

Indeed, the biggest skeptics about energy’s true potential as a long-term investment may be those people who’ve already owned the stocks for a long term.

For now, Wall Street analysts figure Unocal can earn about $2.60 a share this year, a dramatic improvement from 1998 and 1999.

But the consensus estimate for 2001 is for $2.35 a share, or 10% below this year’s estimate.

Why pay a substantially higher price for Unocal, many investors no doubt figure, if the earnings trend is down from here?

Ironically, what the energy industry may need to attract more investors is a pullback in oil and gas prices from their current speculator-driven levels.

“We like having higher prices, but we don’t think that anyone believes that current levels are sustainable or fundamentally good for the U.S. or world economies,” says John P. Herrin, an energy-stock analyst at Merrill Lynch & Co. in New York.

Investors don’t want a price bust, of course--but rather, prices just high enough to make new exploration worthwhile and provide shareholders with decent return on their money, for the first time in a long while.

The problem with commodity businesses, however, is that they are by nature prone to boom-and-bust cycles.

Who trusts OPEC to get it right this time--to maintain production that sustains prices at levels that reward producers (who have had a dismal last 10 years, let’s not forget, which has been to our advantage as consumers) without pushing prices so high that they shock the world into recession?

OPEC clearly doesn’t want a global recession. That would be the fastest way to bring down energy demand and, potentially, trigger another price collapse.

Even if OPEC does get it right, energy investing has more than market-price worries working against it. Let’s face it: Rooting for higher oil company profits is un-American in most parts of this nation, and the world as well.

People hate paying more for gasoline, especially after a decade in which it was so cheap, relatively speaking. And that creates another risk for energy companies and their stocks: If their profits stay healthy, the government may demand a bigger share, as penalty.

When a tech company doubles its profit (Microsoft excluded, perhaps), the government cheers the “new economy.” But when an energy company doubles its profit, politicians believe a felony has been committed.

But amid all of these doubts about the wisdom of owning energy in this new decade, it’s worth asking whether a contrarian view might be worth the risk: If the skeptics are wrong, and the oil and gas industries are at the start of a multiyear profit expansion, a lot of investors who don’t own this sector will have to get aboard sooner or later.

“Energy companies haven’t been viewed to be growth-oriented or as attractive as other sectors,” Herrin says. “Our research indicates that view is changing because of the perception about [oil and gas] scarcity.”

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Domestic Oil Stocks Lag . . .

As a group, stocks of domestic integrated oil companies remain below their record highs reached in 1997, despite soaring oil and natural gas prices this year.

Standard & Poor’s index of nine major domestic integrated oil stocks,

quarterly closes and latest

Friday: 967.64

Stocks in the index: Amerada Hess (ticker symbol: AHC), Ashland (ASH), Conoco (COC/B), Kerr-McGee (KMG), Occidental Petroleum (OXY), Phillips Petroleum (P), Sunoco (SUN), Tosco (TOS) and USX-Marathon (MRO).

Source: Bloomberg News

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. . . as Do Exploration Shares

Shares of oil and gas exploration and production companies

have fared even worse than integrated oil stocks in recent

years, and as a group still are below their highs of 1993.

Standard & Poor’s index of five major

exploration and production stocks,

quarterly closes and latest

Friday: 81.47

Stocks in the index: Anadarko Petroleum (ticker symbol: APC), Apache (APA), Burlington Resources (BR), Devon Energy (DVN) and Unocal (UCL).

Source: Bloomberg News