The drop in oil prices is starting to make oil stocks interesting

Oil prices have taken a 1-2-3 punch over the last three days—which is starting to make oil stocks interesting to me.

Why? Because the big punches–surveys of supply and forecasts of demand from the U.S. Energy Information Agency and the International Energy Agency, respectively–are backward looking. They reflect lower demand because of higher oil prices that peaked (for the moment) at $113.39 a barrel of benchmark West Texas crude on April 29 and at $126.64 a barrel for benchmark Brent crude on May 2. Since then oil prices have tumbled to today’s $98.95 a barrel for West Texas crude and $113.16 for Brent crude. That’s enough to lead to upward tweaks going forward in those demand forecasts—and the tweaks could graduate to revisions if oil falls further in the current commodities rout.

The third punch, hearings in Congress on cutting the U.S. oil industry’s $21 billion in tax breaks as part of any budget deal, grab headlines and allow politicians to posture for constituents, but the effects of this kind of political circus are almost always short-term.

Here’s a blow by blow of the first two punches. Read more

On January 28, I argued that the U.S. economy is still in the early recovery stage of the business cycle, and that you should overweight your portfolio toward the stocks that do best at this point in the cycle: “Sectors that do best are usually industrials, near the beginning of the stage; basic materials; and, near the end, energy.”

 The next stage for the U.S. economy is late recovery. “Sectors that have done well in this stage include energy and, near the end of the stage, consumer staples and services.” (For more on investing for the economic cycle see my post http://jubakpicks.com/2011/01/28/where-the-heck-are-we-in-the-economic-cycle-anyway-the-answer-is-important-in-deciding-what-sectors-to-overweight/ )

See any sector that those two stages have in common? So why not overweight energy right now? several readers asked. That way your portfolio can catch the sector’s outperformance at the end of the early recovery stage and the sector’s outperformance in the first part of the late recovery stage.

That’s an excellent idea. Just be careful what energy stock you pick. The sector is a little tricky to navigate right now. I’d favor being very selective on oil stocks—most of the international majors aren’t all that attractive currently. I’d favor oil equipment and service companies right now and small oil producers that are growing production and that look like acquisition candidates over the oil majors.

And I’m going to end this post with five picks of exactly those sorts. Read more

Oil drilling failure rate surges at the Western majors

It’s not a factor now in the climbing price of oil but the trend certainly doesn’t portend cheaper oil down the road. Or a rosy future for the Western oil giants.

In 2009 Chevron’s (CVX) drilling failure rate climbed to 35%. More than one-third of exploratory wells came up dry. That compares to a 10% failure rate in 2008.

And that’s by no means an isolated increase in the drilling failure rate. ConocoPhillips (COP) saw its failure rate climb to 43% in 2009 from 32% in 2008.

Higher failure rates mean that it gets more and more expensive to find new oil to replace what’s been pumped out of the ground. Chevron’s target is a modest 1% increase in oil and gas production this year. ConocoPhillips is forecasting a 2.7% drop in production in 2010.

The reasons for the climbing failure rate are pretty simple. Read more

With Exxon and Chevron on deck, it’s so far, not so good in the oil sector

And seldom was heard an encouraging word…. At least from the oil producers and oil service companies that have reported second quarter earnings as of the close of trading on July 29.

The best news is that oil companies aren’t slashing capital spending budgets anymore. But no one is increasing them much either on the early evidence from BP (BP) and oil service companies such as Oceaneering International (OII).

We’ll know later today and tomorrow, respectively, if ExxonMobil (XOM) and Chevron (CVX), tell the same story when they report.

Typical of the sector so far is this from BP (BP) CEO Tony Hayward: “We see little evidence of any growth in demand and expect the recovery to be long and drawn out.” Read more

Next week it’s oil, oil and more oil earnings. To know where the industry is going, forget profits and look at capital spending

Exxon Mobile (XOM). Chevron (CVX). Royal Dutch Shell (RDS.A). BP (BP). ConocoPhillips (COP). Noble Energy (NBL) Apache (APA). Petro-Canada (PCZ). All these production companies report quarterly earnings next week.

Add in drilling equipment and oil service companies such as Smith International (SII), Oil States International (OIS) and National Oilwell Varco (NOV) and you’ve got quite a week for oil.

Move over technology, it’s time oil stocks get their fifteen minutes of fame. But what’s most important next week isn’t the topline earnings per share numbers that will grab the headlines. If you really want to see where the oil market and oil stocks are headed, concentrate on what these companies say about their capital spending plans for the rest of the year. That will tell you whether oil company CEOs think we’re seeing a real, sustainable economic recovery that will keep oil prices climbing or a temporary gusher that will dry up in a few months. Read more