"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%.

In fact, 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.

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), Lone Star Technologies ( LSS), Smith International ( SII) 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.
Christopher S. Edmonds is partner and managing director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

If you liked this article you might like

Holiday Portfolio: What a Bunch of Turkeys

Holiday Portfolio: What a Bunch of Turkeys

Holiday Portfolio: Lagging on Labor Day

Holiday Portfolio: Lagging on Labor Day

Holiday Portfolio: Lots of Duds for the Fourth

Holiday Portfolio: Lots of Duds for the Fourth

Holiday Portfolio: A Welcome Break From a Difficult Tape

Holiday Portfolio: A Welcome Break From a Difficult Tape

Holiday Portfolio: Some Broken Eggs

Holiday Portfolio: Some Broken Eggs