Investing In Oil Companies

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Investing In Oil Companies: Here Are Five Oil Stocks Set to Surge in 2008

by Floyd Brown, Advisory Panelist, Investment U
Thursday, January 17, 2008: Issue #753

Since 2002, the price of crude oil has climbed relentlessly from $20 a barrel to $90 a barrel. All of us are tempted to blame big oil under our breath as we pump our tanks full. But rather than complain, I suggest you invest in this sector.
Shares of oil companies that find, drill, refine and distribute oil have seen their shares climb in value along with crude. Today, we are six years into this bull run and the question many oil investors are asking is: When does it end? With the increase in share prices over the last four years, is there still opportunity to be found?

The simple answer is yes. A handful of the stocks in this sector have not performed as well as crude itself, and profits at many of these firms will continue to go up. To be sure, investing in oil companies this year could prove a wise move for many investors.

Here are the five oil companies I like best during the cold winter of 2008…

Crude Refineries Profit On The Crack Spread

Companies that refine crude make their profits on the “crack spread.”

In chemistry, to “crack” means to separate the component parts of a substance; in this case, the extraction of petroleum products from crude oil, including gasoline, kerosene, diesel, heating oil, aviation fuel, asphalt and others. The crack spread is the profit margin an oil refinery can expect to make from these products.

This fall, the price of crude has run up even as gasoline demand has gone down. People like to drive more in the summer than in winter. This demand slack has put pressure on the refiners’ margins, and they are making less spread. Consequently, the market punished these stocks.

As winter turns to spring, I believe that crude prices will moderate while demand for gasoline moves forward because of seasonal demand. So now is a great moment to invest in the following crude oil refineries:

Holly Corporation (NYSE: HOC): Holly owns refineries in New Mexico and Utah. It sells gasoline, diesel fuel, and jet fuel in Texas, New Mexico, Arizona, Utah, Wyoming, Montana, Idaho, Washington, and northern Mexico. The company also manufactures and markets asphalt products from various terminals in Arizona and New Mexico.Based in Dallas, Holly also owns assets in the gas and petroleum transportation and pipeline business. Trading at 7 times earnings, this stock has a large margin of safety. As gas prices go up, you will make money.
Tesoro Corporation (NYSE: TSO): The 90-year-old Kirk Kerkorian, with a fortune north of $18 billion, is the seventh-richest person in the U.S., according to Forbes. He tried to buy a 16% stake in Tesoro, only to be spurned by the board. Kerkorian has built a fortune with smart investments in the airline, auto, hotel, casino and movie industries.Last year, Kerkorian withdrew his tender offer to buy the stake in Tesoro after the oil company’s board adopted a “poison pill” plan. The plan makes it difficult for any shareholder to acquire more than 20% of Tesoro. The board did this because they knew that Kerkorian was getting a great value and they didn’t want to lose control of the company.
Valero Energy (NYSE: VLO): Valero is the King Kong of this sector. Valero Energy owns and operates 17 refineries in the United States, Canada, and the Caribbean with a combined throughput capacity of approximately 3.1 million barrels per day.Bizarrely, this firm is trading at a P/E of only 5.5. It has a price-to-book value ratio of only 1.59. This year, the firm in the capital-intensive refining business has a free cash flow of $5.22 billion. If Valero’s stock gets much cheaper, some vulture investor like Kerkorian will move in and try to buy it.

Investing In Oil Companies & Cashing In

There is also value in the domestic oil services firms; these are the companies that drill for oil and gas and provide a variety of services to exploration and production firms in the United States and Canada. They’ve been under pressure lately because of weak pricing in the natural gas business.

Natural gas prices came down because of an oversupply, which resulted from a string of warm winters. But gas prices are moving up, and I am predicting the day rates on rigs here in the U.S. will also move up.

Well-known value investors like Ian Cumming and Joseph Steinberg of Leucadia National Corporation are investing in this sector. We should be, too.

Here are my two favorite picks:

Grey Wolf (AMEX: GW): An oil and gas drilling company, Grey Wolf doesn’t actually sell the oil it drills. GW provides drilling crews and oil rigs. The day rates it charged declined in late 2007. Besides that, increased costs have pressured profits. And this pricing pressure has lead to a surge in short selling of the stock. Shorts believe that oil is headed lower from the nearly $100 price. And they believe natural gas prices will weaken further. If this happens, it could cause day rates to fall even more, affecting the company’s ability to meet growth projections.I disagree; this stock is already cheap at 6.3 time earnings. The market has priced this stock for no growth. I expect natural gas to make a real rebound in the next couple of years and GW is well positioned to take advantage of that.
Hercules Offshore (Nasdaq: HERO): Headquartered in Houston, Hercules Offshore, Inc., operates a fleet of 33 jack-up rigs, 27 barge rigs, 65 lift boats, three submersible rigs, one platform rig and a fleet of marine support vessels. It has operations in nine different countries on four continents, so it is not just a domestic driller.A director, Steven A. Webster, bought 25,000 shares of HERO common stock, according to a Securities and Exchange Commission filing, the Friday before Christmas. He bought the shares for $23.65 apiece, and you can still get these shares for a similar price. But the sale on shares will not last long.

A final word of caution: Oil is likely to trade with lots of volatility in 2008. Remember, I expect prices to moderate in the first quarter and then start to head up again in the late spring.

My suggestion is that you take your time accumulating shares while investing in these oil companies over the next three months. From there, just watch them head higher. I guarantee you’ll feel better about pulling up to the pump and paying a higher price for gas this summer.

Good investing,

Floyd

Floyd Brown, a contributing editor of The Oxford Club, is the president of Excellentia, Inc., a consulting company specializing in business strategy, development and marketing. And his advice is in high demand: Floyd’s appeared on CNN, CNBC, FOX News, MSNBC, the CBS Evening News, ABC’s Primetime, and NBC’s Today Show. As someone familiar with both Washington, D.C., and Wall Street, Floyd travels throughout the country speaking on public policy and free market economics. He’s also a co-founder of the non-profit organization, Citizens United.

Today’s Investment U Crib Sheet

If you prefer a more diversified approach, companies that produce oil and gas, and those that provide energy-related services, can be scooped up in one trade via the Energy Select SPDR (AMEX: XLE). The fund has 35 holdings, so you’d be getting instant diversification, at least in this one sector. And while you’d be giving up “big winner” potential a single stock can give you, the fund is up 36% over the last 12 months. Not too shabby. You’ll collect a 1% dividend, too.The XLE is trading at just 12 times earnings right now. Both Tesoro and Valero Energy are among its holdings. Take a look at XLE against the S&P…