ENERGY: Supporting Cast Suffers

ENERGY: Supporting Cast Suffers

The agony of motorists has been the ecstasy of the oil business. Gasoline prices hovered above $3 a gallon and crude oil prices stayed higher than $70 a barrel for most of the third quarter, draining consumers' pocketbooks but swelling coffers throughout the oil patch.

But while oil and natural gas prices soared during July and early August, by September they were slumping -- and so were the shares of most energy companies. A variety of factors -- plentiful supplies, the absence of a disruptive hurricane, a slowing U.S. economy and reduced anxiety about geopolitical tensions -- all conspired to push prices down. Even as many oil companies were chalking up record or near-record third-quarter results, investors began taking a dimmer view of their prospects.

The firms hurt most by the pullback in oil and gas prices were refiners and independent exploration companies focused on natural gas production. Valero Energy Corp., the nation's largest independent refiner, fell to $51.47 a share, down 23 percent from the start of the quarter. As a group, refinery stocks fell more than 20 percent from the start of August through late September, according to Jacques Rousseau, an analyst with Friedman Billings Ramsey Group Inc.

Oil-services firms, which had jumped earlier in the year after high prices stimulated higher demand (and prices) for rigs, also fell. Schlumberger Ltd. slid 5 percent to $62.03 a share, while Baker Hughes Inc. tumbled to $68.20, off 17 percent from $81.85. Even Transocean Inc., which specializes in offshore rigs that are in special demand, fell to $73.23 a share, down 9 percent from $80.32.

The major integrated oil companies fared best because of their diverse operations that run from the wellhead to the filling station. Exxon Mobil Corp., the biggest U.S. oil major, began the quarter at $61.35 a share. It climbed to $71.22 a share before easing to $67.10 a share at the end of the quarter. Citigroup oil analyst Doug Leggate said that the current share price represents a modest price-to-earnings ratio of about nine times next year's expected earnings; he said Exxon Mobil usually trades closer to the multiple for the entire market, currently around 15.

Chevron Corp. also edged up, but BP PLC was hurt by pipeline leaks that curtailed production from the Prudhoe Bay field on Alaska's northern slope and by the postponement of production from its Thunder Horse platform in the Gulf of Mexico because of equipment failures in tests. BP, Europe's second-largest oil company, said production fell 0.6 percent from a year earlier to 3.8 million barrels a day. Its shares finished the quarter at $65.68, down 7.7 percent from the end of June.

Analysts covering the energy sector have spent the past month recalculating their outlooks. In early September, Merrill Lynch & Co. analyst Christopher Moore cut his forecasts of refiner profits by 12 percent; on Tuesday, Valero lowered its estimate of third-quarter earnings. On Tuesday, Merrill Lynch also downgraded oil and gas producers, saying that the sector would underperform the broader market. Separately, Lehman Brothers Holdings Inc. downgraded big oil and gas production sector on Tuesday to "negative" from "neutral." Lehman's analysts cited tumbling natural gas prices and rising inventories as well as a rising exploration costs.

Some analysts see the recent fall in oil and gas stocks as a buying opportunity. Leggate believes that share prices have fallen too far. "After seeing the sector hit pretty hard, we're seeing opportunities for investors," he said. "Even at $45 oil, these stocks look attractive."

Where oil prices end up is a crucial question. Fadel Gheit, oil analyst for Oppenheimer & Co., thinks prices will settle at $55 to $60 a barrel and said the Organization of the Petroleum Exporting Countries would significantly cut production if prices fell to $45 a barrel.

John P. Herrlin, oil analyst at Merrill Lynch & Co., forecasts crude oil prices of $65 a barrel for 2007 and natural gas prices of $7 per thousand cubic feet. But Herrlin, who is still bullish on the sector, recently ran different numbers to see what lower oil prices would do to his recommendations. On Sept. 28, he released a report that figured out the impact of $50-a-barrel oil and $6 natural gas. He said share prices were still attractive for investors.