What $50 Oil Means for Energy Stocks

Windy Impacts

Of course, the wild card will be the production impact from Katrina and Rita, especially for Gulf of Mexico producers. Recovery from the twin sisters will likely be a long and tedious event, and it is probable that the earnings of many of the Gulf producers will be challenged.

In addition, it is also possible that service companies will feel a short-term pinch.

With nearly two dozen rigs out of commission, at least temporarily, that means less drilling in the Gulf of Mexico, which means less demand for drill bits, drilling mud, production tubing and the like. Companies like Grant Prideco (GRP Quote), Lone Star Technologies(LSS Quote), Smith International (SII Quote) and others could feel the short-term impact on earnings.

Longer Term, Follow the Rigs

However, the longer term is much more sanguine. As I often say to clients, there are two very simple statistics that strongly suggest that this drilling cycle remains intact.

First, in the last year we have doubled the number of rigs drilling for natural gas and the production response has been nil. And, in Saudi Arabia, Saudi Aramco has nearly doubled the number of rigs drilling for oil and the response? Again, de minimis.

The depletion rate on existing wells continues to accelerate, and we have to drill more just to keep up. Canada and Mexico are seeing increases in demand, which means less exports to the U.S. And, liquefied natural gas won't impact natural gas supply until at least 2009.

Sure, commodity prices won't remain this robust for long. And, as they moderate, energy stocks will also slip a bit.

For a solid investor who understands the dynamics of this energy cycle, that only presents an opportunity to build new positions. While corrections are certain to happen, this bull market in energy still has plenty of juice.