The Last Bargains Left in the Oil Sector

Marathon Oil and three ETFs look like the best bets

Oil futures hit a two-and-a-half-year high Friday, with the price of crude topping $112 per barrel.

Despite what you may have heard about peak oil theory, there is no shortage of crude oil in the world. OPEC stressed that they would boost crude production to make up for any shortfalls, which is good news. The bad news is that Goldman Sachs (NYSE: GS) warned that OPEC’s spare capacity likely dropped below 2 million barrels per day, which is not very reassuring when Libya was producing approximately 1.6 million barrels per day before the country’s civil war broke out.

We’ll have to watch this situation play out to know who is right, but what you really need to focus on in this situation are neighboring Middle East nations, because the next potential dominos in the chain are Bahrain and Saudi Arabia. Saudi Arabia is the world’s largest oil producer, and disruptions to oil productions there would be significant to global output and would put firm upward pressure on oil prices.

While it’s too early to know if this will happen, it does appear that we are in an environment that will support higher oil prices in the near to medium term. And the best way for investors to capitalize on this trend is with three oil ETFs and one top crude stock pick.

Marathon Oil Stock Going the Distance

What is keeping us from increasing our exposure to the sector is that there aren’t a lot of good oil companies to buy. Between low natural gas prices and idle drilling rigs, many U.S. oil companies are not as profitable as you might believe.

The real profits right now are being made in the refinery business, where the spread between heavy and light crude allows refiners like Marathon Oil (NYSE: MRO) to make bigger profits.

The Texas-based company explores for, produces and distributes oil and gas products throughout several countries, including the United States, Canada, Norway and Libya.

In 2009, Marathon reported reserves of 1.7 billion barrels of oil equivalent, including 600 million barrels of synthetic oil from oil sands. The company’s Marathon Petroleum subsidiary operates seven refineries with a total capacity of 1.2 million barrels of crude oil per day.

Marathon Petroleum supplies about 4,600 Marathon gas stations, as well as 1,600 Speedway SuperAmerica gas stations in the United States. Its international exposure and strong U.S. network are what make this the perfect play right now.

In the latest quarter, the company’s sales rose 27% to $20.2 billion. During the same period, Marathon’s earnings rose 98% to $709 million, or 99 cents per share, compared with $355 million, or 50 cents per share. The analyst community is now expecting first-quarter sales growth of 25% and earnings growth of 166%.

This oil stock will put you in an excellent position to profit from the rise in oil prices. Buy MRO below $54.

3 Oil ETFs to Buy

On the exchange-traded fund (ETF) front, I like a trio of funds that gives us exposure to a number of different points of strength that are emerging in the oil sector.

First off, we have the explorer. The iShares Dow Jones U.S. Oil & Gas Exploration Index (NYSE: IEO) consists of companies that actually go out, find and drill for crude oil and natural gas. The fund’s major holdings include big names in the oil industry such as Occidental Petroleum (NYSE: OXY) and Apache (NYSE: APA).

Once crude resources are found, they must be refined and turned into gasoline and other products for consumer consumption. That brings us to our next oil ETF. The iShares Dow Jones U.S. Energy Fund (NYSE: IYE) profits from the big companies that manage this process.

Holdings like Halliburton (NYSE: HAL) and Marathon Oil take crude oil, clean it and help turn it into the everyday products that we use. This oil ETF also contains Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX), which not only provide refining and other services, but also sell products directly through their own gas-station chains.

Before any of the companies in the first two oil ETFs can get anything done, they must rely on the resources provided by the companies in our third ETF pick, the iShares Dow Jones U.S. Oil Equipment Index (NYSE: IEZ). The companies in this oil ETF supply the machinery and tools necessary to drill for and process oil.

IEZ includes 44 holdings, with major interest in big names such as Schlumberger (NYSE: SLB) and National Oilwell Varco (NYSE: NOV). I like this fund because its equipment-related companies don’t feel the impact of fluctuating oil prices as directly as companies in other funds do.

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