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Chicago Tribune: Occidental, Hess ride direction of oil prices

Companies depend more on crude production rather than a balance of oil, natural gas output

By Isabel Ordonez | Dow Jones Newswires
December 9, 2007

Shares of Occidental Petroleum Corp. and Hess Corp. have been among the oil sector’s strongest performers, but they appear to be the most vulnerable to a sharp downward move in crude prices.

Among energy companies, Occidental (OXY) and Hess (HES) hold a special niche.

In terms of market capitalization, they are smaller and less diversified than giants Exxon Mobil Corp. and Royal Dutch Shell PLC, which take pains to balance their assets between exploration and production activities and refining and marketing endeavors. These two business segments often act as a natural hedge: High oil prices compensate for narrow refining margins, and vice versa.

Occidental’s and Hess’ assets emphasize crude-oil production more than the other pure “upstream” players do. “Upstream” is an industry term that refers to the exploration for and production of hydrocarbons, and many upstream companies seek a balance between oil and gas output.

While oil broke through repeated records as it came close to $100 a barrel, natural gas prices have languished for much of 2007, keeping profit in check. About 80 percent of Occidental’s output is crude oil; it’s 70 percent for Hess, according New York-based Argus Research Corp.

Because of these companies’ exposure to crude prices, investors should take a cautious approach if oil prices retreat further, analysts said.

Many industry observers see high oil prices as a temporary surge, saying that conflicts in oil-producing regions will dissipate and that the U.S. will weather winter’s arrival. Some predict that prices will come down when demand drops.

Occidental and Hess have outperformed most energy stocks over the last several months. Occidental and Hess are up 48 percent and 59 percent, respectively, this year, but Philip Weiss, analyst at Argus Research, said both stocks have risen “too quickly.”

“I would not put new money into either stock at current levels,” Weiss said in an e-mail. “My bias right now for both would be to the downside.”

With a continued drop in oil prices, Occidental and Hess likely would see their incomes decline more than other oil firms, and their stock values would follow, Weiss said. So far, however, both stocks are higher than when oil hit its record close Nov. 23, even as crude prices have fallen 10 percent.

Friedman, Billings, Ramsey & Co. recently downgraded Hess’ stock to “market perform” from “outperform,” and Occidental to “underperform” from “market perform.”

Rating agency Standard & Poor’s released a report Nov. 21 that predicted oil prices would stay high but recede from current levels. The firm’s oil-price assumptions for U.S. benchmark crude is $70 a barrel for 2008, $60 per barrel for 2009 and $45 per barrel in the longer term.

Eitan Bernstein, an energy analyst at FBR, said his advice on whether to buy or sell Occidental and Hess stock depends on commodity-price fluctuations.

When crude was trading at $95 a barrel, both companies were making “very good money,” Bernstein said. “Obviously, if crude prices come down, they will be making relatively less. But both companies are quite profitable.”

Bernstein said Occidental has, by far, the highest correlation between crude oil prices and stock performance, followed by Hess, Murphy Oil Corp. and Marathon Oil Corp.

But Weiss said he sees a bigger risk in Hess’ stock.

“Hess has a weaker balance sheet and less free cash flow,” Weiss said. “So if prices fall before new projects came on line it could suffer. … It couldn’t fund its projects.”

Hess declined to comment for this report, but some analysts are confident the company’s production growth will offset lower oil prices.

Hess has an active exploration calendar over the next several months that could help the price of its stock. It expects results from wells in the Gulf of Mexico and in western Australia.

Production growth also could help Occidental reduce the possible effects of lower oil prices. “We are a company that is totally focused on upstream, and the company’s performance continues to be strong,” said Richard Kline, Occidental’s spokesman. He declined further comment.

But Occidental faces more threats than oil price fluctuations, said John Parry, a senior analyst with Greenwich, Conn.-based John S. Herold Inc. He said Occidental’s stock also might suffer the most among its peers if the U.S. imposes a windfall tax on oil and gas companies.

“The majority of Occidental production is in the U.S.” said Parry. “A windfall tax … could be as devastating as a 15 percent or 20 percent drop in the price of oil.”

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