As the first quarter comes to an end, most investors will be glad to put the last three months behind them, hoping this nightmare market doesn't repeat itself in the second quarter.Energy stocks had been an exception but recently even they have been caught in the downdraft. The Philadelphia Oil Service Sector Index, or OSX, is up about 10% year-to-date, but it has given back around one-third of its gains in just the last two weeks. Some more bearish pundits may use the recent weakness in energy stocks to suggest the top has come -- and gone -- for oil and gas stocks. Certainly, there is an argument to be made that seasonal moderation in hydrocarbon demand will lead to a decline in commodity prices. And, as has been argued in these pages before, it will be very difficult for energy stocks to rally with the backdrop of falling commodity prices. That said, the weakness may also create a buying opportunity for longer-term investors. In fact, there are a handful of reasons to be constructive on energy stocks in the coming weeks.
It is clear that most E&P companies should perform well above expectations in the first quarter. The less certain aspect of the numbers game is whether they are ready to project better results for the balance of 2005. But even if the firms leave their numbers for the second through fourth quarters near current levels, the unexpected boost from first-quarter results will cause a bevy of analyst revisions to full-year numbers. And, frankly, with commodity prices showing few signs of cracking, many E&P companies will likely be prepared to move full-year guidance higher. The same is true among the oil-field service companies. Analysts covering this group also remain very conservative in their first-quarter and full-year estimates, even as companies like Nabors Industries ( NBR - Get Report) -- North America's largest contract driller -- have indicated margins are much stronger than anyone expected into the first quarter and likely to improve throughout the year. Not only does that bode well for other drillers like Patterson-UTI Energy ( PTEN - Get Report) and its smaller brethren such as Grey Wolf ( GW), but it should also bolster nondrilling service companies like Schlumberger ( SLB - Get Report), Weatherford International ( WFT - Get Report) and BJ Services ( BJS). Earnings will drive the next stage of bullishness in the energy space. And, even if commodity prices moderate and put pressure on the stocks, it won't take long before investors realize that $40 oil and $5.50 natural gas are an energy bull's dream for equities.
The largest energy conference of the year always makes news, and this year should be no different. Plus, with companies very cognizant of fair disclosure rules, the news will travel fast because any material facts will be filed in public documents before formal presentations in New Orleans. As a result, look for upbeat outlooks, production updates and even some guidance revisions ahead of the conference, which begins on Monday. In addition, just like any big industry conference, there will be plenty of chatter. I will look for plenty of bullish talk about longer-term commodity prices, the potential for an acceleration of merger activity among exploration companies, future liquified natural gas (LNG) development as a source of domestic natural gas and the surprising growth in international markets for energy service companies. All of those threads would be positive for energy stocks in the coming week. That said, there is also likely to be a contrarian view that cites a record turnout for this year's event as a sign that the trade is more crowded than ever. And, while the cycle will remain intact regardless of the rhetoric from HW, the trick will be to determine which investors are just window shopping, which ones are buying and how many showed up to return merchandise for refunds.
Demand from Asia and anticipation of increased summer demand for crude products in the U.S. and Europe may well lessen the seasonal decline in commodity prices, at least according to ESAI, a Boston energy consulting and strategy firm. "As China assumes a larger percentage of global demand, the relatively strong Chinese demand in the spring compensates for the fall in demand elsewhere," says Rick Mueller, oil manager at ESAI. In fact, ESAI believes that with the relatively warm winter this year in Asia depressing kerosene demand, the fall in Asian OECD demand should be less than normal in the second quarter. According to ESAI, global demand fell by more than 2.2 million b/d in the second quarter of 2003, but by only 1.5 million b/d last year. "This year, we are forecasting an even smaller contraction in the spring," says Mueller. While prices are still likely to show some moderation, ESAI's argument, if true, provides even more support for the $40-plus oil thesis and, as a result, $5.50-plus natural gas. If those prices are even close to correct, these potential catalysts for energy stocks could help energize your portfolio in the weeks to come.