Energy Prospectus

Below is the summary from the most recent Raymond James “Energy Stat of the Week,” as published 5/10/2010.

Despite the subdued atmosphere due to the Gulf of Mexico tragedy, we came away from the single biggest oilfield conference thinking that business is better than a year ago with hopes for a steady improvement for the remainder of 2010. Overall, inbound orders and activity are improving. Manufacturing companies haven't really been able to push pricing higher yet, but business is much healthier than a year ago when the industry's focus was on implementing numerous cost-cutting measures (or survival mode). Based on our numerous conversations, the hottest business in the sector is pressure pumping. As such, we would highlight the manufacturers of pressure pumping equipment such as National Oilwell Varco and FMC Technologies. Additionally, the Big 4 (Schlumberger, Halliburton, Baker Hughes, and Weatherford) should benefit more than most as will Complete Production Services and Key Energy.

As for the fallout from last month's deadly offshore rig explosion, many questions remain with arguably the biggest unknown of how Gulf of Mexico drilling will be impacted going forward. Speculation on the potential causes and possible repercussions from the disaster ran rampant throughout the conference. Regardless of the findings/recommendations of the federal investigation, there is certainly a renewed emphasis on equipment/service quality. Going forward, we anticipate that quality integrity will be of greater importance than ever before. In other words, companies will be less willing to buy sub-par products to save a buck or two. All in, the conference highlighted the fact that business is better than last year and expected to improve throughout the remainder of this year. Also, the industry is bracing for the fallout from the federal investigation over the Gulf spill and the recommendations that are to be delivered on May 28 to President Obama.

From RJ "Energy Stat of the Week" dated May 24:

There are three key issues that appear to be driving short term oil prices: 1) the U.S. dollar; 2) the broader stock markets; and 3) bloated Cushing inventories. On the dollar issue, we would start by saying we are by no means currency experts. That said, the recent dollar strength appears to be a relatively simple flight to quality. Yes, both Europe and Japan have bigger structural imbalances between spending, income, and debt than the U.S. While these issues may tend to support a stronger dollar for awhile, Washington's own fiscal state of affairs isn't exactly rosy. The Fed's (and most of the rest of the world's) printing presses should be very busy over the coming years as the budget deficits are monetized. While relatively recent history (2008 and 2009) would suggest that a downward trend for the dollar will imply rising oil prices, for most of 2010 the two have decoupled. We think this lack of oil-to-dollar correlation will increasingly hold in the future, since the underlying fundamentals of the oil market and the currency market are simply not the same. Over the long run, oil and the dollar are driven by different variables and have no lasting relationship. To be sure, we have a bullish long-term thesis on oil, but this is premised on our view of the oil market's supply/demand fundamentals rather than what we think about foreign exchange rates. In short, we think the dollar will be increasingly less relevant to oil prices.

The opposite is true for the correlation between oil and the S&P 500. The recent tight positive correlation between oil and the broader markets is a radical departure from past history. Usually the two are inversely linked. Our sense is that this correlation will be a significant oil price driver as long as the macroeconomic shadow of the "Great Recession" dominates market discourse. This may well be the rest of 2010 and perhaps even longer. It also implies that a continuation of the current broader market pull back could imply additional declines for oil. Conversely, a market rally should put some upward pressure on oil. In the long run (two to three years out), the relationship should revert back to its historical norm of being an inverse one. The reality is that higher energy prices are simply not positive for the remainder of the economy, and thus for the broader market.

The final consideration for short-term oil prices are the bloated inventories at the Cushing oil hub in Oklahoma. There have been three times over the last several years where bloated Cushing oil inventories have driven a short-term (one- to three-month) disconnect between WTI oil prices and global oil prices. We are currently in one of those price disruption periods. The good news is that these periods tend to be short lived and should lead to a two- to four-dollar rally in WTI relative to Brent in the coming months.

The bottom line is that short-term oil prices remain very much a broader stock market and global economy call for the next few months. Bloated Cushing inventories could continue to add further near-term pressure to any additional stock market declines. That said, we believe both of these potential negative oil drivers will be relatively short-term in nature and could create excellent buying opportunities for "oilier" stocks. Our favorite oil-weighted ideas include:

In the E&P space: Concho Resources, Pioneer Natural Resources, and Whiting Petroleum; In oilfield services: Weatherford, Cameron, and National Oilwell Varco; and Among the majors: Chevron and Hess.