Can Oil Stocks Sustain Rally?

Think low oil inventories and heavy demand mean oil-related stocks will keep rallying?

Don’t bet on it.

Be cautious, at least, say oil analysts and money managers.

Yes, the steady climb in oil prices fueled incredible rallies in oil prices — as well as oil-related stocks. No stone has been left untapped as shares of companies engaged in various stages of oil production, processing and distribution are trading near 52-week highs.

The October Brent crude oil futures contract — a commonly quoted oil futures contract and an indication of the market’s sense of the direction of oil prices — traded Wednesday near a 10-year high.

While this mini energy crisis is expected to continue into the winter, investors don’t believe stock prices have much higher to go.

’Someone Will Find More Oil’

The market is already anticipating a crunch caused by incredible demand. It’s possible inventories will increase. And there’s always the weather, the other unpredictable factor in oil demand.

“Everybody’s going to chase these stocks, and they’ll be paying big bucks for all the oil-service and oil-equipment and subcategories stocks,” said Doug Myers of IJL Wachovia. “Then someone will find more oil. These stocks tend to be feast or famine-type stocks.”

A 19 percent rally in the Philadelphia Stock Exchange Oil & Service Sector Index, or OSX, over the last four months should inject some caution. So should a 10.2 percent gain in the American Stock Exchange Oil & Gas Index. Energy stocks tend to rally in the summer months in anticipation of increased fuel needs in the winter, and that effect has been more pronounced this summer as oil prices exploded. OPEC has increased production, but not enough to offset demand.

Oil-service giant Schlumberger closed trading Wednesday at 87 5/16, an all-time high. ExxonMobil closed at 84½ not far from its 52-week high.

The Long and Short of It

On a short-term basis, momentum and continued concerns about oil inventories could carry these stocks higher.

The long-term prognosis isn’t bad either. Oil-service companies, which pulled back on exploration due to years of low oil prices, are likely to expand operations. When oil prices are high, there is an incentive for drilling and exploration companies to increase exploration operations. Transocean Sedco Forex is just off its all-time high. Exploration companies Apache and Anadarko Petroleum also hitting new highs earlier this week.

It’s the Medium Term That’s Shaky

The short-term outlook is strong. The long-term outlook is strong. It’s just the medium term, the next six months, that looks shaky. The winter months tend to be unkind to oil stocks. Generally, stock prices tend to dip in the winter in anticipation of the slower summer months. And low inventories can be somewhat deceiving. “The market fully appreciates the situation for the oil stocks,” said David Brady, portfolio manager of the Stein Roe & Farnham Young Investor fund. “Clearly, it’s a time of year where you hear about talks of potential shortages. It’s not too unusual to see these stocks rally, but it causes me to be a little cautious going into this time of year.” Indeed, the Philadelphia Stock Exchange Oil & Service Index fell 21.8 percent between September 1999 and December 1999. Over the past week, crude oil inventories fell 7.77 million barrels to a 24-year low of 279.71 million, bringing inventories to their lowest level since 1976. That’s 35.38 million barrels below last year’s level. Gasoline inventories fell 1.14 million barrels to 203.34 million, down 4.6 million barrels from a year ago.   These inventories will probably stay low for a while. The stocks, meanwhile, might not stay so high.