Tickers in this Article: BTU, CHK, BUCY, PBR, NBL, COP
It's been a downright nasty week for the energy sector, and the quarter hasn't been much better. The sector as a whole is down more than 10% over the past five trading sessions (as of September 9, 2008). The price of crude oil has now dropped 40% from its peak levels in early July, and it has spearheaded the declines for pure-play exploration and production names like Noble Energy (NYSE:NBL) (down more than 45% since July), and even the vertically integrated producers like ConocoPhillips (NYSE:COP), which is down more than 20% in the same period.

Infection Spreading to Energy & Commodities
In recent days, stock losses have spread out much farther than pure oil plays, leading many market watchers to postulate other theories as to why industries like Agricultural Chemicals, Aluminum, Coal, and Oil & Gas Services have seen intense selling pressure. One theory that's been quick to the lips is forced selling by hedge funds that were riding the momentum wave in commodity-based stocks. (Learn to buy high, and sell higher in our related article Riding The Momentum Investing Wave.)

We do know that at least one large hedge fund, the flagship Ospraie Fund run by Ospraie Management LLC, was forced to liquidate its portfolio after losing over 28% in the month of August alone. The fund began the month with about $2.8 billion in assets and was once the biggest player in the commodities field.

Global Growth/China Theory
The other theory with the biggest potential to drive the losses we're seeing is the "slowing global growth" stance. Many analysts point to the steep declines in stock markets around the globe, but this is partly a self-fulfilling prophecy. In most emerging stock markets, energy and commodity-based stocks tend to dominate the major indexes. These markets are, in aggregate, rich in natural resources and net exporters. So if their largest companies are seeing the same energy-based stock declines, the broad indexes of these nations will show inordinately poor returns.

China is the X factor in the latter theory; nobody is quite sure how much growth the nation will churn out in the face of a 58% decline in the Shanghai index and high levels of inflation. Because China is far and away the world's fastest-growing energy consumer, the fates of many stocks will rise and fall with Chinese demand, especially over the short term, as the U.S. and Western Europe are at or near recession-level consumption.

Appreciate the Fear
With all the caveats now thrown out there, I see some real bargains appearing in the energy sector. The selling action Monday smelled of panic. Brazilian oil giant Petrobras (NYSE:PBR) was down 11%, shedding over $17 billion in market value in a single day. There was no negative news on the company, no downgrades or earnings warnings - just a 3% drop in crude oil futures. Never mind that crude oil was trading $20 cheaper the last time Petrobras stock was this low.

Long-term investors should cheer moments like this when the markets appear to over-correct or just plain panic. Sometimes the best decision an investor can make is to run toward the crowd while the crowd flees.

I've picked out a few names from the sector that appear to be on sale, along with an overarching word of caution: given the volatility in oil prices and all the energy stocks of late, there could be more big swings before new ranges and trends are formed.

  • Peabody Energy (NYSE:BTU) - The largest U.S. producer of coal has seen its stock drop more than 25% in the past week, yet spot prices for coal are essentially flat over the last month, and China is running dangerously low on coal inventories. Peabody shares trade for 16-times this year's earnings estimates, and less than 8-times fiscal 2009 estimates.

  • Bucyrus International (Nasdaq:BUCY) - This maker of heavy equipment for surface and underground mining is down more than 35% in the past 10 days. Bucyrus has beaten earnings estimates by 10% or more in each of the past five quarters and recently upped its guidance for the full year. While the company's largest market is coal, its equipment also sells to miners of iron ore, oil sands, and copper. Shares trade for about 14-times this year's estimates and 11-times fiscal '09 estimates. (For related reading, see Can Earnings Guidance Accurately Predict The Future?)

  • Chesapeake Energy (NYSE:CHK) - Chesapeake is the largest independent producer of natural gas, and it has seen its staple commodity also fall precipitously, to the tune of 45% in the past six weeks. However, the seasonal peak period for natural gas use (winter) is approaching, and the company has been selling small equity stakes in its rich shale assets for huge dollar figures. Recent deals have pegged two of their larger gas deposits at over $16 billion, and Chesapeake has gotten their new investors to help shoulder a big portion of the ongoing drilling costs. Shares can be picked up for less than 10 times fiscal '08 estimates.

Parting Thoughts
Investors looking to establish positions in these names should consider averaging in over a period of several months. Remember, the ultimate driver of commodity prices is not simply the price of oil this month versus last, but rather long-term demand growth versus known supplies and production growth.

If you are a believer in the long-term trends of emerging market growth, global energy demand, and per capita income gains, these stocks should be a valuable, albeit volatile, addition to a diversified portfolio. The upside is that current stock prices are based partly on stalled growth in the U.S. and Europe. As either side of the pond starts to rebound, there should be more demand for commodities which will put the wind at the back of prices.

Do you think oil is heading higher or lower than $100 per barrel? Are commodities a bursting bubble, or is this the second inning of a nine-inning affair? Join me in the Stock Picking Community (EpiphanyOne) to discuss your views and make your stock picks for all to see.

To learn more about investing in this volatile sector, read our Oil And Gas Industry Primer.

comments powered by Disqus

Trading Center