Where Deals in Oil Stocks Are
We've entered a bear market for oil. After doubling in just one year, oil prices have shed 20% since peaking at $147 a barrel on July 11.
Tim Guinness says prices could drop to $100 in the short term. But then prices will spike again by 2010 or 2011 as the fundamental imbalance of supply and demand reasserts itself, he says. "The only way to balance the market is by choking off demand, which would require a spike above $200," says Guinness. "Oil has been very cheap; now it's becoming rather expensive."
Not surprisingly, London-based Guinness, co-manager of Guinness Atkinson Global Energy (symbol GAGEX), is bullish on oil stocks. Over the long run, he says, prices of oil stocks generally follow the trend in oil. But in recent years, stock prices have lagged prices for the commodity. Guinness says many companies can boost profits dramatically with oil at just $100 -- and he sees his job as finding stocks that will rise more than oil prices will.
Here's how Guinness analyzes the supply-and-demand picture. When oil prices spiked in the early 1980s, consumption fell because natural gas and coal were used instead for power generation and heating. This time he reckons it's much harder to displace oil because of surging demand from the developing world and lack of easy substitutes in oil-hungry industries, such as transportation and petrochemicals.
On the supply side, he focuses on growth in non-OPEC production, which has been shockingly weak in recent years. "Everyone expected a normal market response to higher prices would be an expansion of production, but that hasn't happened," he says. Output is up in some places, such as Canada, West Africa and Brazil, but that's been offset by a rapid decline in the North Sea and Mexico.
Guinness picks about 30 energy stocks from 270 around the globe. He looks for oil-and-gas companies that he calculates are cheap relative to proven reserves and have an ability to increase production.
For instance, he likes Petro-Canada (PCZ), which he says can increase output 5% to 10% annually for a number of years. Another favorite is ConocoPhillips (COP), which he likes less for its growth than for its cheap price and ability to tap into copious free cash flow to buy back shares at a furious rate.
In the services-and-equipment arena, two of his stock picks are Transocean (RIG), the largest deepwater driller, and Halliburton (HAL), a big provider of oil services. Halliburton is often overshadowed by industry leader Schlumberger, but Guinness says Halliburton sells at a large discount to Schlumberger and will grow faster.
For oil-exploration companies, Guinness likes Hess (HES), which has a successful reserves-development profile around the world, and StatoilHydro (STO) of Norway, which is a leader in deep-sea operations, a hot area in oil and exploration.
Guinness has co-managed Global Energy with Edmund Harris since the fund's inception in June 2004. In the past three years through August 6, the fund returned an annualized 16%, an average of 13 percentage points a year better than Standard & Poor's 500-stock index and in line with a benchmark of natural-resource funds. Guinness Atkinson carries an expense ratio of 1.37%.