Energy Stocks Haven't Caught Up With Oil Prices

By Alejandro Lazo
Washington Post Staff Writer
Sunday, March 23, 2008

Energy companies have recorded whopping profits as the price of oil has surged over the past year. But while shares of those firms have traditionally tracked oil prices, they haven't kept pace this time around.

The cost of one barrel of oil on the New York Mercantile Exchange, for example, has doubled in a little over a year, rising from $50 in January 2007 to $101.84 last week. Yet the S&P Energy Index, which tracks the stocks of major energy companies, has risen only about 26 percent over the same period.

The reason, analysts said, is that oil prices have been driven to record highs by more than just demand for the product.

The decline of the dollar, in which commodities are priced, has helped make oil more expensive. At the same time, large institutional investors seeking shelter from the recent volatility of the stock market have rushed into commodities, driving up the price of oil and other goods on speculation, analysts said.

"Obviously, the $100 oil has not pushed the stock of oil companies," said Fadel Gheit, an oil analyst with Oppenheimer. "The high oil prices have resulted in record profits for the companies but have not benefited their stocks."

Gheit said the reason for the stocks' more gradual climb is that "nobody believes that oil prices are sustainable at the current level." Suggestions by many economists that the United States is either about to enter a recession or is already in one have led many analysts to predict that consumers will cut back on consumption of gasoline, which is widely expected to reach $3.50 to $4 a gallon this summer.

This week provided evidence to support Gheit's point of view. The price of oil plummeted 7.7 percent after hitting a record high of $110.84 a barrel on March 13.

The decline was driven partly by the same investors who had rushed into oil and other commodities rushed back out again, returning to financials stocks after the Federal Reserve moved to prop up the banking system.

In addition, heavily indebted firms have unloaded their investments in raw materials such as gold and oil in a bid to reduce risk and amass cash at a time when liquidity is crucial, analysts said.

"The largest speculators are the largest financial companies," Gheit said. "This is what created the artificial bubble we have."

That kind of volatility involving oil and the companies that make their money from it is likely to persist in coming months. Big institutions in search of cash could continue to shed their investments in oil while the price is still high. Other investors may bet that the dollar has finally hit bottom after a steady drop against foreign currencies. And a slowing economy would lessen demand for energy.

Randy Bateman, chief investment officer for Huntington Asset Advisors, said he remains bullish on the energy sector.

"Our philosophy is that there is going to be a great deal of demand from developing countries such as China and India," Bateman said. "And demand from these companies is still going to be pretty high, irrespective of what happens to the U.S. dollar."

Price volatility affects the bottom lines of individual companies differently, depending on which part of the industry they're in. Oil companies generally fall into three groups: production, refining and oil services.

Large production companies such as Chevron and Exxon Mobil are likely to be the most subject to swings in the price of oil. Even with the recent downturn, the overall upward trend of recent years has brought them enormous revenues. Exxon Mobil posted world-record profit in the past two years, taking in $40.6 billion in 2007.

Refiners such as Valero Energy, Tesoro and Sunoco are also vulnerable to swings in demand and tend to have smaller profit margins than the big producers. Large companies such as Halliburton that offer services to the producers have less direct exposure to shifts in the price of oil and currently stand to reap the benefits of increased spending on the part of the large producers.

"Really, I think the producers are going to be the ones that are going to have the most psychological swings when there is a downturn in oil prices," Bateman said. "But drillers, pipeline companies, the proppants manufacturers -- they are all going to have huge demand for their services."

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