The Federal Reserve is on record as stating that higher commodity prices like crude oil are merely temporary. But with crude oil prices stuck at $100 per barrel, it is hard to imagine that view being correct. That means oil stocks like Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) are some of your best investments now.
On Wednesday, oil prices moved higher after having traded lower due to strength in the U.S. dollar. The reason for the move was tied to reductions in crude supplies. This follows the recent move by OPEC to keep production levels constant dashing hope of those looking for more supply.
Things big time Thursday, however, with the news that the Obama administration was set to release 30 million barrels of crude from the strategic oil reserves. The move is part of an international effort to address supply disruptions caused by turmoil in the Middle East and Libya turmoil. Crude prices dropped by more than $4 per barrel immediately on the news.
Historically government intervention in markets is not sustainable. In some cases intervention can cause the opposite effect as speculators with deeper pockets bet against any sort of market manipulation.
In the case of crude we have the oil markets staring at 727 million barrels of oil stored in salt caves along the Texas and Louisiana border. Certainly the government can represent a credible threat to the market, but what is the real likelihood that it will use that threat?
The strategic reserves were created for emergency purposes, and Wall Street insiders they have been rarely used since hording supplies began during the 1970’s oil embargo. In other words this is not a long-term plan that will weigh on Exxon, Chevron or other oil stocks. The likely outcome of this little blip is that oil prices will revert to market pricing once the excess supply is absorbed.
Of course, stocks like CVX and XOM moved sharply lower on the news of the strategic reserve release, but many names have been weak since March. In fact considering the proximity to $100 per barrel prices, oil stocks were cheap before the recent selling.
For example Apache Oil (NYSE: APA), a top oil and gas producer, has lost value in 2011. Shares are down 3% year-to-date. That makes no sense given the profits this company makes. Wall Street expects the company to make $12.06 per share in the current fiscal year with that number growing by 10% to $13.3 in the following year.
Shares of Apache stock trade for less than that expected growth rate at 9.6 times current year estimates. Considering the company beat estimates by thirty one cents per share in the first quarter of 2011, it is reasonable to assume that the company will do best estimates for the full year as well.
Offshore oil driller Atwood Oceanics (NYSE: ATW) is faring much better. Atwood shares are up 8% this year, but have traded flat since February. Shares are stuck at $40 per share. Over the last three quarters Atwood Oceanics has exceeded profit estimates that have been too conservative given $100 crude.
Wall Street estimates for Atwood profits in the current fiscal year ending September 30 are at $3.95 per share. Analysts are looking for conservative profit growth of only 5% in the following year from ATW stock. Given that tepid growth forecast, shares of Atwood look fairly priced. The stock trades for just over 10 times current year estimates.
Oil refiners like Tesoro have also done very well with higher oil prices. Tesoro Petroleum (NYSE: TSO) is up a whopping 83% over the last 12 months. I would be a seller at current prices. The refining of crude is notoriously difficult with thin profit margins for those in the business. Oil price volatility does not help matters.
Wall Street currently expects profits to drop in the 2012 fiscal year as compared to 2011 expectations. With the tug and war between oil traders, OPEC, and governments volatility in crude prices is almost certain. I’d take profits in oil refiners like Tesoro today.
The absolute best way to play oil stocks at the moment is with the large integrated oil companies like Chevron (NYSE: CVX) and Exxon Mobil (NYSE: XOM). Chevron is up 7% this year and Exxon is up 6%. Both companies also pay investors rich dividends with all that cash they are making from higher oil prices. Exxon pays a dividend of 2.3% and Chevron pays investors 3.1% per year.
At the end of the day I don’t think oil prices will moderate any time soon. Despite the soft patch in the economy at home, conditions remain conducive to growth. That growth is likely to keep oil prices high no matter what the government tries.
