NEW YORK ( TheStreet) -- Oil prices may be falling, but the industry is gearing up for longer-term growth, offering investors a potentially prime opportunity to profit from the energy sector.
A study of capital budget expectations of more than 400 oil and gas companies published by the Barclays Capital commodities research team showed that global exploration and production spending in the industry will surpass a half a trillion dollars in 2011. Spending should rise 16% to $529 billion this year compared with $458 billion last year. This is a positive sign for oil prices.
The report attributes the robust year-over-year increase to large spending increases in both North America, up 16.2%, and outside North America, up 15.5%. In December, Barclays forecast a smaller increase of 11% globally, 7% in North America and 12% outside North America.
The bigger budgets alongside higher oil prices and the expectation of rising oil prices are consistent with historical trends, the authors of the report said. "The correlation between exploration and production spending and inflation-adjusted oil prices is significant and we expect a high oil price environment to persist over the next several years driven by ... continued difficulty finding and developing large reserves, increased demand especially in emerging markets and tight spare capacity."
"This is setting the stage for further growth in spending in 2012 and beyond, and 2011 is likely to mark the first year of the restarting of multi-year, double-digit growth in global exploration and production spending."
Oil and gas companies collectively are basing their 2011 capital spending budgets on an average price of $87 a barrel of West Texas Intermediate (WTI) oil. In early December, their average oil price expectation was $77 a barrel. The Barclays commodities team meanwhile predicts that WTI oil prices will average $106 a barrel for the year, $137 for 2015 and $185 for 2020. Its Brent forecast is $112 for the year, $135 for 2015 and $184 for 2020. Roughly 23% of the companies Barclays spoke with suggest that if oil prices were to average $90 to $100 a barrel this year, they would increase spending, while only 3% said they would decrease spending. About 74% of the respondents said they would not adjust their spending plans for 2011. The vast majority of those surveyed say they expect to increase spending in 2012, with nearly half forecasting expenditure increases of 10% or more, the Barclays analysts said.
Kate Warne, U.S. investment strategist with Edward Jones, recommends a 12% portfolio weighting in energy stocks -- neither underweight or overweight, which is roughly in line with the S&P 500 index's energy sector weighting. Warne likes the diversification the energy sector offers. "It trades with oil and natural gas prices rather than the rest of the market," she explains.
Within the energy sector, investment advisers are generally recommending oil-weighted stocks over gas-weighted stocks, given that they have a bullish outlook for oil and bearish outlook for North American natural gas. Typically, the U.S.-traded, natural gas pure plays are overwhelmingly exposed to the U.S., rather than international natural gas markets, which receive a much more bullish outlook from analysts. "Right now, we definitely have a weighting towards the oil. We like the fundamentals better," says Standard & Poor's analyst Michael Kay. Plus, "You never know what's going to happen politically out there."
That said, a tolerance for volatility may be required of oil investors, whether in the commodity itself or the equities. Oil prices, of course, have a tendency to be volatile -- in 2008, oil prices hit a peak of $147 a barrel before retreating to the mid-$30 range that year; then it popped back up over $100 this year. "There is going to be volatility in this industry. There's no way around it," says Argus Research Group's senior energy analyst Philip Weiss. "It's a cyclical industry."