Energy Looking Up?

The start of 2006 proved to be a roller-coaster ride for energy investors, but many on Wall Street say cheap valuations and the prospect of higher oil and gas prices could drive shares higher in the next few months.

After gaining nearly 16 percent in January, the Amex Oil Index proceeded to shed almost 10 percent in February, as an abnormally warm winter cut the legs out from under what had been record natural gas prices.

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Gas has rebounded somewhat though, crude has remained firm at well over $60 a barrel, and the index has added back about 5.5 percent this month, making a run as a worse-than-normal hurricane season looms. Nonetheless, on most metrics, fund managers say energy stocks are still undervalued.

"I think now that that is digested, people are looking at some reasonable values; our view is that crude oil prices are going to remain high," said Ben Halliburton, chief investment officer of Tradition Capital Management in Summit, New Jersey.

"When you look at the natural gas situation, January was an aberration as far as consumption, but production of natural gas in the United States peaked three years ago," he said.

Other analysts agreed that the fundamentals were right to support natural gas prices, which should in turn keep the sector propped up and diminish the chances of more February-style dips.

"Heading into summer, we continue to see fuel switching, growing demand, supply curtailments, and summer heat and weather offsetting each other and pushing natural gas prices higher," Friedman Billings Ramsey said in a note this week.

The Arlington, Virginia-based firm also said there was upside room for gas producers heading into earnings season based on the average gas prices for the first quarter, even with the drop in February.


Nonetheless, the downward pressure on the stocks during the quarter has been enough to help push them to attractive valuations on most metrics.

While the benchmark S&P 500 index has a ratio of price-to-expected-2006-earnings of about 16.1, Exxon Mobil Corp. (XOM) has a ratio of 10.7, Chevron Corp. (CVX) comes in at just 7.9 and ConocoPhillips (COP) at only 6.6.

"Right now they're cheap as heck," said Robert Lutts, president of Salem, Massachusetts, fund firm Cabot Money Management, who is overweight oil services companies in particular.

"I think everyone's trying to be the hero to call the end of the trend, but I think this could be a very long-term substantial beneficial trend for investors, to stay long energy," Lutts said.

While more expensive than the integrated oil producers on a price-to-earnings basis, investors are paying close attention in particular to oil services companies and drilling companies, who are already being stretched to their limits by demand.

"If you think there's going be a hurricane issue this season, oil services (are the way to go)," Lutts said, adding services companies are running full tilt to meet demand and are having trouble adding staff. "If you throw another hurricane into that environment it's just going to get even better."

Last week private forecaster AccuWeather said the 2006 hurricane season will be more active than normal — this after 2005's season broke records and boosted shares of companies with limited exposure to the Gulf of Mexico.

From Katrina's Aug. 29 landfall through year-end, the AMEX Oil Index gained 3.3 percent. Over the same period, EOG Resources Inc. and XTO Energy Inc. gained more than 20 percent, while Comstock Resources Inc. and Cabot Oil & Gas Corp. added 10 percent or more.

That said, Tradition Capital's Halliburton said he thought the market was discounting last year's hurricane season as a once-in-a-century anomaly and not pricing it in this year.

Instead, he saw value in drilling companies, with tightness in the rig market and day rates that are rapidly rising to new records. He said driller stocks could appreciate 50 percent or more over the next year, highlighting companies like Patterson-UTI Energy Inc. in particular.

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