Staying Bullish on Energy

 | Sep 28, 2012 | 12:30 PM EDT  | Comments
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While oil did not rise after the formal QE3 announcement by the Fed, we think its gains in the weeks leading up to it were, in large part, in expectation of such an announcement. We also believe that continued very low interest rates and an exceptionally easy monetary policy should provide both a floor and resilience to oil prices in the range of current price levels.

In the past, the price of oil has risen in the wake of quantitative-easing announcements, with a flocking to hard commodities as more reliable stores of value. In the case of oil, the result has been demand-driven price inflation. We expect this phenomenon should continue to support oil prices and will likely give oil prices an upside bias.

At the $90- to $98-a-barrel level, there are also a number of additional cross-currents. The tendency to see higher oil prices after easing announcements has been tempered this time by global economic and industry considerations. The slowing Chinese economy has temporarily eased fears about China's insatiable energy demand. Within the U.S., the mid-$90s level has also seemingly resulted in some demand destruction.

At the same time, supplies have been strong. Indeed, Saudi Arabia has announced its willingness to increase production levels if need be. This announcement is likely driven by a desire to defang any threats that might be made by Iran in response to sanctions designed to stop its march toward nuclear weapons.

At the moment we also think the Saudis believe that oil prices are in a Goldilocks-like sweet spot in the mid-$80s to $90s, and they don't want to see the energy market getting off-kilter.

So, we are likely to continue to see oil prices in the $90-ish range for the foreseeable future, absent some extraneous geopolitical event or events. In this environment, we continue to like many areas of the energy sector.

All things considered, we believe that the service stocks look particularly appealing. In this regard, we highlight two of our previous suggestions, Schlumberger (SLB) and Tidewater (TDW).

Schlumberger is the leading global oil service stock. Unlike some of its competitors, its focus is worldwide and is heavily oil-centric. The current and forecasted price range makes looking for new wells economically compelling. Multiyear commitments are being made now in this regard, and Schlumberger is more often than not the go-to company for sophisticated, challenging projects.

As we said back in our July 26 update about Schlumberger, investors have the chance to invest in a world-class company that is seeing a demonstrable uptick in its business prospects, and which should bear results in the near and intermediate term.

Schlumberger has risen since but less than the overall market, which, to our way of thinking, means that the train hasn't yet left the station and there is still time to invest.

Tidewater should also be a significant beneficiary of an oil industry focused on finding new drilling opportunities. This marine-based service provider has one of the newest and most robust fleets in the industry and should be a big beneficiary in a global pickup in offshore drilling activity and pricing.

Management's take is that the company is in the third inning of a strong multiyear upcycle in the industry. Tidewater has had favorable fundamentals in the last few months and also had modestly better news in regard to its negotiation with its Angola relationship. At the same time, the stock has been fairly flat, which we think provides a good entry opportunity.

Industry leading service companies should provide steadily growing earnings, consistent business prospects and manageable volatility going forward. A firm floor to current oil prices increases our confidence in that bullish call.

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