An oil mystery that spells opportunity

There's an intriguing gap between the price of crude oil and the price of oil-service stocks. But how do you exploit it?

By The Fiscal Times Nov 15, 2011 12:27PM

Image: Oil drums (© Kevin Phillips/Digital Vision/age fotostock)By Suzanne McGee, The Fiscal Times

There's a mystery in the oil patch.

An intriguing valuation gap has opened up as the price of West Texas Intermediate crude oil has recovered to about $98 a barrel, only 2% below levels seen in July, while oil services stocks haven’t bounced back nearly as much.

The two investments are typically tightly linked, Canaccord Genuity analyst Scott Burk says, so that anomaly opens up the prospect that either crude oil is due for a selloff (of up to 16%) or oil services stocks are set to rally in order to close that gap.

Typically, as crude oil prices climb, so do shares of those stocks because investors expect that exploration and production companies eventually will respond to the higher prices by hiring more rigs and drilling more wells in order to boost output to capture those higher prices.

This time, however, stock market investors remain deeply skeptical about anything that suggests that economic growth may be lasting or sustainable and are reluctant to bet that traditional linkage will remain intact. So prices of stocks like RPC (RES), Basic Energy Services (BAS), and Haliburton (HAL), remain in the doldrums, at least on a relative basis. "There isn’t the conviction that oil prices will stay this high," says Burk.


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You could always flip a coin: Heads, oil prices will fall, making the stocks fully valued, or tails, the gain in crude prices will stick, transforming the oil services stock into bargains. Or you could follow Burk’s advice and buy a group of the most appealing stocks while hedging out the commodity price risk by establishing a short position on crude oil prices. "We think oil prices will hang in there unless there’s another big recession, but this is a strategy that means you don’t have to make a market call on crude oil," he explains.

In the world of onshore drilling, Burk and Canaccord Genuity have "buy" recommendations on Halliburton, Basic, and RPC. Atwoods Oceanics (ATW) and Enservco (ENSV.OB) are their top picks among offshore drillers.

Canaccord Genuity isn’t the only investment firm to make bullish calls on the sector. Last month, Jefferies (JEF) issued a positive call on both on- and offshore drillers, although its analysts noted that movement in stock prices might have to await upbeat comments from the exploration and production companies that hire the drilling outfits regarding their capital spending plans for 2012 before any sustainable rally materializes.

So toss a coin or hedge your bets: either way, there’s a valuation anomaly here for savvy investors to exploit.


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