The Wall Street Journal: Despite Oil's Heady Climb, Finding Winning Energy Stocks Isn't So Easy
May 18, 2004
Charles Ober's oil-market savvy makes him a popular guy at the office these days. For the past 24 years, Mr. Ober has either co-managed or managed T. Rowe Price's $1.5 billion New Era Fund, the nation's oldest natural-resources mutual fund by the firm's estimate, started in 1969.
And having your finger on the pulse of energy markets isn't a bad thing, given worries over instability in Iraq and tight crude-oil and gasoline inventories. The price of crude oil for June delivery reached $41.55 a barrel Monday on the New York Mercantile Exchange, its highest close since trading began in 1983.
While that's good for oil companies, higher prices are pinching many other companies' profits. Consider how rising gas prices raise costs for airlines, manufacturers and shipping companies. So, his fellow money managers at Baltimore-based T. Rowe are cornering Mr. Ober and asking where oil prices are headed next, and we thought we'd do the same.
Mr. Ober officially took the fund's reins in 1997, and over the past five years he's averaged a 7.7% annualized gain, topping the Standard & Poor's 500-Stock Index by more than 10 percentage points annually. And thanks to surging commodities prices, his fund is up 27% over the past 12 months.
That said, investing in oil and other energy stocks is hardly a simple endeavour these days. While rising oil prices have boosted earnings at major oil outfits, it's not the case for all -- Royal Dutch/Shell Group and Halliburton Co. have been hit by accounting scandals in recent weeks. At the same time, Shell and other firms are having a tough time finding more oil.
So, are high oil prices here to stay? What about the rest of the natural-resources sector, and where is Mr. Ober investing today? We got some answers.
1. What's your take on oil prices today and where they're headed?
Oil is trading at almost $41 today [Friday]. It seems like oil stocks are priced as if everyone expects prices to be $23 or $24 [a barrel], but I [see oil prices] being in the $28 to $30 range for the longer term. That's partly because of the lack of ability among the major firms in finding big new drilling areas. While there is a lot of potential in areas like Russia, it's hard for a western company to get in there and build up relationships and business.
If you flashback to 1990, the decade prior and the decade subsequent, you see a real shift in where you've seen incremental growth in oil supply. It's gone from places like the U.K., Norway and Canada to places like Russia, Chad, Angola, Kazakhstan, Azerbaijan, Nigeria and Iraq. You're looking at countries with a lot of strife, in addition to long, exposed pipelines. That represents a constant risk, considering that terrorists are increasingly aware of the fact that choking off oil supply is a great way to disturb things.
2. The price of oil is high, but why haven't oil stocks moved up?
In the past, there have been periods when you've had a disconnect between the stocks and the price of oil. That's usually because people look past that period and try to normalize oil prices, using more normal prices in their models.
Also, it's true that the companies haven't been performing particularly well. Shell is certainly the poster-child of that, given its reserve problem. Most of these companies still had trouble making their return targets despite ebullient oil prices. That's because they neglected to seek out opportunities and invest in exploration. So, the results haven't been particularly good. I think they're changing for the better, but it will take some time. When we talk about the companies, we're talking about aircraft carriers, not speedboats.
It's also worth remembering that basic-materials and energy stocks have really receded in the investor's mind. In 1980, basic-materials and energy stocks were about 40% of the S&P 500. Now they're about 8%. Investors haven't paid much attention to these companies or given them much funding.
3. Where are you investing now, and which companies would you single out as the best-managed in the energy sector?
We think the oil-services industry will ultimately benefit as oil companies have to spend more money to find more oil. That's based on the fact that I think oil prices will stay high for a while, and these company's economics stay pretty robust.
Today, we think there's opportunity in the base metals and in the precious metals, too. But incrementally we've been moving a bit into paper. Also, we've been moving a bit more into companies in the fertilizer business because part of what's happened with China's growth is that global grain inventories have hit record lows. With higher prices for grain and soybeans, we think framers will have to plant more.
In terms of the best companies, Exxon Mobil Corp. has been a superior performer over time. They've shown a great deal of discipline in investing for growth, buying back their own shares and making acquisitions when their own stock is high. The stock sells at a premium, and I'm not necessarily buying it today, but I think it's a great long-term investment.
Total SA, the French oil company, is another solid option. They have a great portfolio of development projects underway and have a very disciplined financial approach to running their business.
Baker Hughes Inc. is one of my favorite oil-service companies because it has a broad array of offerings that help it really appeal to major clients. The company can go into many areas of the world that more specialized competitors can't.
4. How do high prices for oil and other commodities pinch profits for businesses?
You might first look at a company in the service industry. A classic case is airlines. They can't pass on higher fuel prices quickly enough to their customers [through higher prices]. But even natural-resources companies can get hurt by rising prices for commodities. You'd think steel would be a good business right now, but some steel producers have to buy cooking coal to make steel. The price of cooking coal has risen further and faster than the price of steel.
Even look at a company like McDonald's, where a large portion of the company's cost of goods sold is labor or even fuel to some extent. There you're going to expect inflation to chew at away at the company's bottom line.
5. What's the case for investing in natural-resources companies today?
Most of these companies in this area haven't invested in capacity to build up natural-resource production for quite some time. Companies have gotten so very little capital that supply hasn't really grown much and yet were seeing global demand picking up and accelerating thanks to emerging markets like China. So supply is short and demand is rising, which is what you want to see as an investor.
6. Are there more problems regarding reserve accounting?
I think it's basically a Shell issue. They were just overly aggressive. There was a lot of ambiguity in some of the ways that the definition of reserves was maintained over the years. In the end, companies like Shell and others, like El Paso Corp., were just too aggressive in booking their reserves.
I don't think it's an industrywide phenomenon. I don't think it means global oil reserves are less than we thought. In fact, Shell will likely rebook 50% of the reserves it had to un-book over the next five years. The oil is there. So, it's not a major problem for the industry, but it was a warning sign, and I'm kind of glad to see it happen because it puts everyone on guard. Before you even ask now companies all say, "No, we haven't overbooked."
As for Shell, I think the only question at the moment is what comes from the SEC's investigation and the investor litigation. I can't imagine it will be terribly onerous, and it's in their favor that they'll be rebooking the reserves they recently unbooked…. I think the company's management is better now than it was before. It could be a long road, but the company will re-establish its credibility. The stock is in the fund and we added to the position as this thing blew up.
7. What's your biggest worry today beyond terrorism?
Well, [terrorism] is a big worry for the stock market, but being invested in many oil companies and gold, that's not actually as big a worry for me. I worry more about the global economy and the sustainability of this recovery. We're going to see bumps in the road for the economies of China and India, but I think they'll be bumps, not collapses.
Write to Ian McDonald at ian.mcdonald@wsj.com