A Top-Down Look at Energy

 | Jan 30, 2012 | 10:16 AM EST
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Once in a while, it's important to speak from a macro perspective on energy, leaving aside specific stocks -- even if we don't come up with a grand portfolio strategy, we'll at least be more nimble in our timing of entries and exits. And right now, the energy investment picture is a very mixed bag indeed.

On the macro level, oil prices are strong and steady -- but for the wrong reasons in almost every fundamental way. The IEA report last week showed a big reduction in the acceleration of oil usage worldwide -- proving again how useless the IEA is at prediction -- and we can see a steady drop of prices for oil throughout the energy curve, a backwardation that would normally be a very bearish indicator.

Opposing these mostly bearish fundamental forces we have the Federal Reserve formally targeting inflation, a move that will have every asset and portfolio manager looking again to reallocate into "hard" assets, meaning metals and oil. This move is another boost for Oil's Endless Bid -- which, if you haven't heard, is still on Business Week's best books list of 2011 -- as is continued Mideast tinderboxes always on the verge of igniting, with Iran almost always leading the list.

Which way will she go? Oil has been steady at about $100 a barrel domestically and $110 in the EU, and almost impossible to carry short. So if oil can't continue to creep up, it's difficult to imagine it going down significantly right now. Steady and strong.

Inside the energy sector, the stocks are not particularly compelling. Big multinational integrated stocks have begun to report, and the song remains the same -- lower volumes and difficulty downstream, which still gives you monster profits that get the news lead but does nothing to get me excited about growth potentials. In short, ExxonMobil (XOM) and Chevron (CVX) are just fine, but they're trading higher than they should, due to their compelling dividends -- the secret to overperformance in the past year and a half. In natural gas, the latest sequestering of drilling by Chesapeake (CHK), Consol (CNX) and others is significant, ultimately drawing a fifth or more of the national daily supply from the cash market, but it won't make a difference for months and is not a sustainable path anyway for debt disasters like Chesapeake (as the JPMorgan downgrade and Phil Weiss of Argus have correctly assessed).

So, what's the upside of all of this downside? For me, the one value to focus on has been the oil services group, where huge underperformance over the past four months or more means the group is due to play catch-up to these very sticky oil prices. The latest ruling in the BP (BP)/Transocean (RIG) fight from the Macondo disaster (now almost two years old, incredibly) went in RIG's direction. This decision might give a positive look-through to the Gulf of Mexico, where we may finally be getting closer to a return to normal in drilling volumes and operations, possibly boosting the prospects for other deepwater drillers such as National Oilwell Varco (NOV) and rig service companies like Superior Energy Services (SPN) and Cameron (CAM).

We have to remember, however, that the equity markets have been unusually strong too, and most of the "smart guys" are talking of a pullback, and I will admit to taking money off the table in the past week -- 8%-12% gains since the start of the year will do that.

So there's the quick macro energy view. Looks like a time to be careful, to be sure.



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