Energy Cycle Shifts

With energy stocks struggling to catch a bid, many investors are wondering if this is the end of the oilfield cycle. Combined with the decline in both crude and especially natural gas, there appear to be some worrisome signs on the horizon for energy equities.

To say the stocks have not had a good week may be an understatement. Through early Friday morning, the energy complex -- as measured by the Philadelphia Oilfield Service Index (OSX) -- was down nearly 8% for the week and about 14% off the highs set in mid-May. Nobody can argue that such a sharp correction isn't painful.

However, recent history suggests such corrections in the oil patch are followed by meaningful rallies. In 2005, for example, the OSX saw two 15%-plus corrections that were followed by rallies to new highs. While past performance is no guarantee of the future, the recent volatility in the energy complex shouldn't be considered out of context with activity of the past several months.

However, there are some differences that deserve mention and some strategies that should make sense as investors position themselves in energy in the coming weeks.

First, technology and innovation will continue to be important in the oil patch. As exploration becomes more complex and new horizons are considered, companies with new technologies will continue to be at the forefront.

One name discussed in these pages before is FMC Technologies(FTI). The company posted solid results for the quarter and increased guidance. At the recent offshore-technologies conference in Houston, the company was awarded a "best in show" award for its new subsea processing technology. It will go commercial next year, and the technology has the potential to reduce costs of subsea production and ultimately increase recovery from offshore fields. Once proven, oilfield experts put the potential market in the billions of dollars of the next decade, with little current competition.

Also on the technology front is National Oilwell Varco(NOV), the leading manufacturer of rigs and rig components. Earlier this month, the company launched a new rig prototype, the Rapid Rig, that is a quick-mobilization rig that can be operated by a crew of three. Not only does the rig reduce the labor needed to drill mid-depth wells (up to 11,000 feet), but it also automates several rig operations. Combined with its other rig-construction and services business, the company's backlog should continue to support performance well into 2007.