The Wall Street Journal: Who Is Hurt By Oil’s Fall?

Drillers, Ethanol Makers Lead Pack
Of Stocks That Could Be Hit Hardest
By GREGORY ZUCKERMAN and ANN DAVIS
January 19, 2007; Page C1

•  The Issue: With crude-oil prices slipping, energy-company shares also have been hit.
 
•  What to Do: Investors must examine which companies will be hurt the most if oil stays down.
 
•  The Bottom Line: Analysts say some oil-company shares have held up but most are wary about some alternative fuels.

THE ARTICLE

Oil prices are sliding, and energy shares are skidding.

Now, investors are trying to figure out which companies will be hurt most if oil stays down amid a relatively warm winter and ample global supply.

“Some oil shares have held up better than expected,” says Jack Ablin, chief investment officer at Harris Private Bank in Chicago, which has $50 billion in assets. “But profit expectations are getting slashed.” He says Hess Corp. is vulnerable because it historically has been sensitive to crude-oil prices but lately its shares have held up surprisingly well.

At 4 p.m. yesterday in New York Stock Exchange composite trading, shares of Hess were down 46 cents to $48.79.

Yesterday, front-month crude-oil futures dipped below $50 at one point, for the first time since May 2005, finishing the day at $50.48 a barrel, losing ground because of a report about large inventories.

Oil companies that have generated the most enthusiasm during the past two years, such as those based in the Canadian oil-sands region, like Suncor Energy Inc. and Western Oil Sands, could be at risk. Suncor, which has a dividend yield of just 0.40% and has about $1.7 billion of debt, is up more than 110% during the past two years, compared with a climb of 45% for Exxon Mobil Corp., which has a 1.8% yield and has more cash than debt.

Suncor has entered into futures-contract deals that guarantee the company a price of at least $51.64 a barrel for 60,000 barrels a day in 2007, or about 23% of its daily production. Beyond this year, however, the company has hedged much less of its production.

It cost Suncor about $25 to produce a barrel of oil in the third quarter of last year, the company’s most recent estimate, so Suncor will still profit if oil heads lower. But a prolonged slump in oil would hurt the company more than others in the oil patch. The company estimates that a decline of a dollar a barrel for crude reduces after-tax profit by almost $50 million.

“We don’t need high oil prices for this business to work,” a Suncor spokesman says. “However, certainly our share price has been tracking oil prices.”

The company’s shares were down 52 cents to $72.06 on the Big Board yesterday.

Among larger oil companies, ConocoPhillips, which spent $35 billion last March to buy Burlington Resources, could be hurt if oil prices keep tumbling, some investors say. Others say that oil-service companies, like Tidewater Inc., could be risky. In previous oil downturns, drilling-company stocks have taken it on the chin because they operate with a high degree of operating leverage, or their earnings are most sensitive to moves in oil prices. Larger drilling companies include Grey Wolf Inc., Rowan Cos. and Nabors Industries Ltd.

As oil’s price falls, alternative-energy sources become less attractive because they usually are more expensive to produce than traditional sources. Ethanol producers could be hurt as rising corn prices send their cost of production higher, and as crude and gasoline prices fall.

In fact, the price at which ethanol producers can sell their fuel has plummeted even faster than the price of crude.

Since Jan. 3, ethanol futures contracts on the Chicago Board of Trade have dropped 24.9% to $1.87 a gallon yesterday. Crude prices fell 13.4% in that period. Ethanol is off 55.8% since its peak price on June 20. On average, according to Goldman Sachs, corn represents 60% of the variable cost of an ethanol plant, and power costs including natural gas represent 25%. Corn closed at a 10-year high yesterday of $4.1225 a bushel on the Chicago Board of Trade, and prices have doubled over the past 12 months.

Publicly traded ethanol companies include Aventine Renewable Energy Holdings Inc. Pacific Ethanol Inc. and VeraSun Energy Corp. Archer-Daniels-Midland Co. is the largest ethanol producer based on gallons produced. Large grain producers in the Farm Belt, like ADM, have made investments in part based on high oil prices.

According to Credit Suisse research, ethanol makers were able to pull off a profit of 86 cents a gallon in the middle of the summer when oil was around $70 a barrel and corn was just $2.50 a bushel. Today, with oil near $50 and corn above $4, they incur a loss of 21 cents for every gallon they produce.

Credit Suisse analyst Mark Flannery told clients in a report yesterday that if these market conditions remained throughout 2007, earnings will drop 38% at ethanol producer Aventine and 58% for VeraSun.

But alternatives mightn’t take the beating that some expect. For one thing, some, like wind power, compete more directly with natural gas and coal, which fire electricity plants and haven’t suffered as much as oil prices lately.

Perhaps more important, concerns about global warming and U.S. dependence on foreign oil aren’t likely to dissipate — especially with a Democratic-led Congress — even if oil prices fall sharply, suggesting that demand will remain for many alternatives, argues Pearce W. Hammond Jr., an analyst at Simmons & Co. International, an energy-investment bank in Houston.

Among the big players in wind, Vestas Wind Systems AS, a large wind-turbine manufacturer in Denmark.

–Lauren Etter contributed to this article.

Write to Gregory Zuckerman at [email protected] and Ann Davis at [email protected]   

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