"Lions and tigers and $60 oil. Oh my!"
That appeared to be the reaction of some energy stock traders on Tuesday as exploration and production as well as oilfield service stocks took a tumble when oil prices began to come back to earth after two devastating hurricanes.
What if I told you that, absent another major storm, I believe oil will pull back to $50 in the next several weeks? (Of course, instead of a storm there could be a supply disruption in the Middle East. Or just maybe civil unrest in Nigeria. Hmm, possibly budget problems in Mexico. Additional challenges to energy capitalism in Russia? Perchance supply problems in Venezuela?)
But, just for a minute, let's forget about all the possible supply issues that could surface, and assume production is "back to normal" in the next several weeks and oil prices return to some "rational" level in the $50 range.
What does that mean for energy stocks?
Opportunities on the Horizon
As oil works its way back to some base price -- I'll use $50 in this case because it seems like an easy, round number to work with -- energy stocks are likely to correct just as we saw Tuesday.
But, for many of these oil and gas companies, there is little difference between $50 oil and $60 oil, and when prices settle at a new baseline, investors should begin to realize the significant earnings power. The worry over a price decline has to be put in perspective: Oil prices slipping from the mid-$60s to $50 is much different than oil tumbling from $30 to $15, like roughly 20% vs. 50%.
I have argued before
and continue to believe that oil prices in the $40s are much better for the sustainability of the bullish energy cycle than oil prices above $60. At current prices, there are well-reasoned worries about high prices leading to demand erosion and a crimp in the economy. However, the economy has shown its resilience -- at least before hurricanes Katrina and Rita -- to $40-$50 oil.
Sure, oil producers that are unhedged make more money with higher prices. But even with $50 oil as an average price for the fourth quarter, earnings estimates remain well below where actual results are likely to fall.