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Financial Times: Lex Column: Inflectious enthusiasm

Published: August 3 2007 03:00 | Last updated: August 3 2007 03:00

Investors in oil stocks, perhaps worried about contagion, should also be wary of inflection. The oil forward curve has flipped over, with spot crude now commanding a premium to longer-dated contracts, having traded at a discount for the past couple of years. What does that change mean in terms of which stocks to own?

In theory, exploration and production companies should benefit from the tighter market that the new curve suggests. On Wednesday, the US reported a big fall in crude inventories. That did not stop the oil price from falling, however. The fact is inventories are still above their five-year range, so further falls will not necessarily support prices. Indeed, Bernstein Research points out that since 2004 – as more speculative money entered the oil market – crude prices have tended to follow inventories downwards.

One alternative subsector, pure refiners, is also suffering. Companies such as Valero have enjoyed Google-esque share price performance since 2004 as rising demand for fuels finally squeezed out the industry’s excess capacity. Heavy maintenance schedules in the US, keeping refineries switched off, provided a last hurrah in the first half of 2007. But the latest fall in crude inventories came alongside inventory increases for most refined products. With more refineries back online, refining margins have duly fallen sharply.

Inflection points usually portend volatility. That is amplified by the general panic gripping the markets. In that environment, oil aficionados might consider turning defensive and buying some laggards of recent years: the bigger integrated majors. BP offers some scope for gains from a recovery angle although its heavy weighting to the upstream business leaves it relatively more sensitive to oil prices. Royal Dutch Shell is cheaper, trading on about 10 times 2007 earnings, and offers a more balanced portfolio. ExxonMobil, at 12.5 times, is on a premium. On the other hand, Exxon is the bluest of blue chips, with net cash and share repurchases of $7bn a quarter. In an ailing equities market, that is strong medicine.

Copyright The Financial Times Limited 2007

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