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Posted on: Sunday, March 14, 2004

Oil firms in portfolio can grease returns

By John Waggoner
USA Today

Home equity loan rates are close to all-time lows, which is a good thing: You'll need one to fill your tank. The average price for a gallon of unleaded gasoline was $1.728 last week, just shy of August's record of $1.737.

Even if you get a horse, you'll still get stung by high oil prices. The price of oil is a factor in nearly everything you buy, from potatoes to plastics. One way you can reduce the pain at the pump, however, is to add a little grease to your investment portfolio.

Ralph Wanger, former manager of the Acorn fund, notes that we shouldn't be terribly shocked by increases in energy prices.

Adjusted for inflation, oil prices are about the same as at the end of 1974. Furthermore, while there are many alternatives to oil, from wind power to solar power to hydrogen, none is feasible for large-scale use now. For at least the next decade, and probably more, most of our energy is going to come from the old standbys: oil, natural gas and coal.

And that's a problem. U.S. oil production peaked in the 1970s. Natural gas peaked in 2001. "We're starting to exhaust oil basins that are big, close and reliable," says Fred Sturm, manager of Ivy Global Natural Resources fund. "People don't drill four miles below the Gulf of Mexico because it's fun." Companies now need to get $20 to $25 a barrel to make production worthwhile, he says.

Energy demand will grow as the population increases and consumers in India and China buy more cars and air conditioners. "That means, in the very long term, higher energy prices," Sturm says.

Light sweet crude oil costs $36.78 a barrel, more than triple its low of $11.37 in 1999. Dan Rice, manager of State Street Research Global Resources fund, figures about $5 of that is speculative excess, inspired by price momentum and terrorism fears.

Barring catastrophe, oil should settle back to about $30 a barrel this summer, he says.

Rising oil prices haven't been exactly overlooked on Wall Street. Integrated oil companies, for example, have fared well. ExxonMobil has gained an average 5.1 percent a year the past five years, assuming reinvested dividends. That may not sound like much, but the S&P 500 is nearly flat the same period.

Oil exploration firms have been running on higher octane. Occidental Petroleum has gained 50 percent the past 12 months, versus 23 percent for ExxonMobil. Murphy Oil is up 55 percent.

The question, then, is whether the energy sector will continue to hit pay dirt. J.C. Waller, manager of Icon Energy fund, says that the energy sector as a whole is about 7 percent undervalued, which isn't much to get excited about. He estimates that exploration companies are 7 percent overvalued. So you aren't likely to find bargains in the drilling companies.

But two energy plays do stand out, managers say:

• Oil services companies. Drillers are pricey, but companies that make the drills and the rigs aren't, says Michael Hoover, manager of Excelsior Natural Resources.

One favorite: Nabors Industries, which has extensive drilling operations but also owns more than 900 land rigs. It's up 11 percent the past three months. Another well-known company: Schlumberger, up 24 percent the past three months.

• Coal. The United States may not dominate the oil patch, but we're the Saudi Arabia of coal, says State Street's Rice. It costs about $30 a ton to mine coal. Coal prices have risen to $52 a ton. But the price of coal stocks reflects coal at about $36 a ton. Sturm likes Arch Coal and Peabody Energy. Both have operations in the Powder River Basin in Wyoming, an area noted for low-sulfur coal deposits.

• Environmental play. One is KFx, which takes low-grade coal and reprocesses it into cleaner, high-grade fuel.

Unless you're willing to ride your horse to work, you'll just have to live with higher gas prices. But adding a bit of energy to your portfolio might ease the pinch.