Oil stocks coming back into favor

April 05, 1995|By Andrew Leckey | Andrew Leckey,Tribune Media Services

Oil stocks are flowing into the nation's investment portfolios in a big way in 1995.

It's no coincidence that this long-awaited deluge is occurring in what's likely to be the first year during the 1990s that oil prices themselves actually went up.

After a quick, temporary price spike to more than $40 a barrel because of the Iraqi invasion of Kuwait, world crude oil prices have been gradually trending downward. However, because of an increase in worldwide demand, an average gain in price of $1 to $1.50 a barrel is quite possible this year.

This still constitutes a modest increase, so motorists needn't be worried. At the pump, this year's summer driving season should experience only a small boost of 2 to 4 cents a gallon.

There are a number of reasons to consider investing in oil stocks these days. Investment analysts are bullish because dividends are strong and equity prices have been handily outperforming the market averages. Best of all, the price rise probably isn't over yet. Some Wall Street computer models point to a 20 percent upside stock price potential, compared to downside risk of only 5 percent.

Furthermore, most oil companies have changed fundamentally for the better. "There's a cultural revolution going on at the oil companies as they become more focused on profitability, reducing costs and managing their business more effectively," noted Steven Pfeifer, analyst for C. J. Lawrence/Deutsche Bank Securities.

In a period of modestly higher oil prices and refining margins, these companies can generate some surprisingly strong earnings gains, he believes.

"The only real wild card that could put downward pressure on oil prices would be if Iraq returned to the market this year, but I'm assuming that it won't and that OPEC production will continue at about 25 million barrels a day," said Michael Mayer, managing director and analyst for Wertheim Schroder.

Uncertainty also surrounds Russia, whose oil production has fallen sharply over the past five years. However, that beleaguered country's oil consumption has also fallen significantly, so Russian oil exports should remain at the same constant level of the past three years. No significant increase in Russian production is expected until the end of this decade.

Of course, there's always potential for Russian social or political unrest, natural disasters or a failure of its antiquated equipment to cause a disruption in supply that could result in higher prices.

"The oil market is politically charged, and we will see disruptions in supply in coming years, just as we've seen in past years," said Doug Terreson at PaineWebber Inc.

He is positive on both international and domestic oil stocks over the next two years because of "an unusual confluence of events" that will have a positive effect on earnings.

Some analysts aren't convinced that oil prices will be rising. For example, Frank Kneuttel, oil analyst for Prudential Securities, expects prices to remain flat this year.

"While demand is rising due to good economic conditions worldwide, non-OPEC nations will gain virtually all of the incremental demand," Mr. Kneuttel predicted. "OPEC will once again be unable to boost its prices."

However that scenario plays out, oil stocks are expected to outperform the S&P 500, and their dividends are well above average.

The oil analysts interviewed for this column agreed among themselves on many potential selections.

Amoco Corp. (with a recent dividend yield of nearly 4 percent) is a stock recommendation of both Mr. Kneuttel and Mr. Mayer; Mobil Corp. (nearly 4 percent) is favored by Mr. Mayer and Mr. Pfeifer; Occidental Petroleum (nearly 5 percent) is a pick of Mr. Kneuttel and Mr. Terreson; and Royal Dutch Petroleum (around 3.5 percent) is suggested by Mr. Kneuttel and Mr. Pfeifer.

In addition, Chevron Corp. (with a recent dividend yield of nearly 4 percent) is a favorite of Mr. Mayer; British Petroleum (around 2 percent) is a Terreson selection; and Phillips Petroleum (just over 3 percent yield) and Unocal Corp. (just under 3 percent) are Pfeifer choices.

The price history of West Texas Intermediate crude indicates how this market can change, a reality that investors should keep in mind.

The average price was $30.30 a barrel in 1983; $29.34 in 1984; $27.99 in 1985; $15.05 in 1986; $19.19 in 1987; $15.98 in 1988; $19.68 in 1989; $24.52 in 1990; $21.54 in 1991; $20.57 in 1992; $18.45 in 1993; and $17.03 in 1994.

Some estimates call for an average of $18.50 a barrel this year.

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