Opportunity: Oil and Gas Sector

Copyright © 2008, Greenwich Financial Management Inc., a registered investment advisor.

We have discussed in this column on many occasions the doctrine of contrarianism. The really big money in investment is generally made going against the crowd. Recently, in the last six months, we have seen a collapse in the prices of many commodities, as world markets have recoiled from over-inflated expectations and the prospect of prolonged recession. The collapse in fossil fuel prices has been dramatic. Light sweet crude oil is currently trading at $34.63 (NYMEX futures contract “CL”) for February delivery versus a high about $100 higher last July. Natural gas is trading around $4.71 per thousand cubic feet (NYMEX Henry Hub pricing) versus a high of about $13.50 last July.

My thesis is that: 1> Numerous projects that could produce more oil and natural gas are in the process of being shut down, thereby limiting supply. 2> Demand will reassert itself, both from developed and emerging markets, as the recession eases. 3> It will not be easy or simple to conserve enough, or substitute other fuels enough, to meet future excess demand. 4> As a result, the value of oil and gas reserves will once again increase.

I was driving in Central New Jersey and I noticed that Lukoil is offering regular gasoline for $1.60 per gallon. Pretty good price! So, if you disagree with my thesis that such prices are bottoming out and heading higher, go crazy, get yourself a Hummer.

Probably the most conservative way to play this investment hypothesis it to invest in one of the great integrated oil companies that have large proven reserves. Among such companies, the following selections are based on a blend of criteria, but including particularly balance sheet strength and operating momentum. The firms with strong balance sheets will not only survive but will also have the chance, in this harsh environment, to make attractive acquisitions of properties and companies. The recommended investment horizon is two to five years; these are not short-term recommendations.

Of the large integrated oil companies, I recommend particularly at this time Occidental Petroleum (ticker: OXY, $55.54 per share as of 1/23/2009 close of trading), Imperial Oil Company (based in Canada) (IMO, $31.50), Royal Dutch Shell Oil (RDS-A, $48.30) and Petroleo Brasileira (“Petrobras”) (based in Brazil)(PBR, $24.58). For a broader diversification, I would also add exposure to Exxon Mobil (XOM, $78.04) (one of the best run among the integrated companies), Chevron (CVX, $70.82) and Hess (HES, $57.54).

Note: Clients advised by Greenwich Financial Management Inc. may hold long or short positions in securities mentioned in this article or in derivatives of those securities. The author of this report has no personal holdings or interest in the referenced investments and has received no compensation for providing the above research from any of the listed companies. The information is not sufficient by itself to make an investment decision. The suitability of such investments for particular individuals has not been assessed.

Andrew Szabo CFA is managing director of Greenwich Financial Management Inc., a registered investment advisor. Questions call 917-796-8500 or e-mail Szabo@GreenwichFinancial.com). For more information, please visit http://greenwichfinancial.com/.