Analysis: Energy Stocks Finish 2010 on Positive Note

Despite a poor start, more than 65 percent of oil and gas stocks delivered positive returns last year, according to the IHS Herold 2010 Energy Peer Group Stock Market Performance Report. Driven by economic growth, crude prices, which hit bottom in late May 2010 at around $65 per barrel, rose steadily and consistently through the second half of the year, and took oil company shares with them.

The median gain for the 503 stocks covered in the report was 21 percent, which, while it did not match the record-setting 59 percent gain posted in the 2009 IHS report, did outperform the market indices of nearly all Organization for Economic Cooperation and Development (OECD) countries. Total capitalization jumped by more than $300 billion, further reducing the severe losses the sector incurred in 2008, but did not extinguish them.

"Sometime in the first quarter of 2009, equity markets began to move upward in response to the economic growth that was becoming apparent in OECD countries," said Robert Gillon, senior vice president and co-director of energy equity research at IHS. "It seemed as though every statistic that confirmed expansion was under way was reflected in a rise in the price of crude, which boded well for oil stocks. That pattern continued throughout the year, with oil prices and oil shares at a recovery high at the closing bell of 2010. In particular, North American oil stocks delivered the most returns to their investors."

After finishing second-to-last as a peer group in 2009, U.S. Royalty Trusts earned redemption by taking top honors in 2010 as the best performing peer group reviewed, posting a gain of more than 44 percent. MV Oil Trust led the group by posting a return of 111 percent.

Companies in the E&P Limited Income Partnerships group followed closely with gains of nearly 43 percent. According to the IHS report, these survey-leading returns were in response to monetary stimuli by numerous central banks, where open-market interest rates fell to the lowest levels seen in decades, which forced yield-conscious investors to take on more risk in order to maintain their desired level of income.

"The vast amount of liquidity being injected into the economic system, particularly in the U.S. has resulted in a strong correlation between equity prices and oil prices," Gillon noted. "By contrast, for many years prior to 2009, there was a reverse relationship, with higher crude prices perceived to cause a reduction in disposable income, lower consumer spending, and declining domestic product and stock prices. To our mind, this is the normal state of affairs, but to predict we will be back to normal in short order would be unwise."

Mid-sized U.S. E&Ps, led by McMoRan Exploration Company, generated a segment return of nearly 42 percent, outperforming every other group of oil and gas producers globally. McMoRan delivered a total return in 2010 of nearly 114 percent.

UK-based EnCore Oil plc, whose shares rocketed by 773 percent following the discovery of the Catcher field in the UK North Sea, was the runaway leader of the Smaller E&P Companies Outside North America, but among companies starting at more than $0.50 per share, UK-based Xcite Energy Ltd. stole top survey honors for best total return of 552 percent due to its North Sea heavy oil project. Notably, Xcite Energy was also the top performer in last year's survey.

Pacific Rubiales Energy enjoyed splendid results with its heavy oil development program in Colombia, and the sizzling gain of 131 percent placed the company at the top of the list of Largest Oil and Gas Producers for a second year in a row. CNOOC Ltd. maintained the title of largest capitalization amongst the Largest Oil and Gas Producers by a very wide margin. The Chinese producer, which had a steaming 56 percent total return, is the first in this sector to have its market valued exceed $100 billion.

Amongst the Largest Integrated and Diversified Oils, top-ranked Ecopetrol's 84 percent gain reflected rapidly growing oil production, and it also got an updraft from the soaring Bogota market. Sunoco Inc. and Valero Energy, last year's bottom two performers in the Largest Integrated and Diversified Oils group, moved into the top 10 due to a dramatic turnaround in refining margins. BHP Billiton is the only member of the 2009 crop to repeat in the top 10 this year.

In a stunning turnaround, nine of last year's top 10 finishers fell to the bottom half of the table in 2010, with Petroleo Brasileiro and Rosneft Oil, numbers one and two in the previous ranking, being hit particularly hard. Thanks in part to the Greek financial crisis, European markets were among the worst-performing financial exchanges and companies there had a tough 12 months, the report noted. Eni, Spa and Husky Energy repeated in the group's bottom 10. BP plc, as anticipated following the Deepwater Horizon incident, suffered through a horrendous year and now ranks eighth by capitalization, down from second in 2005.

While oil stocks carried the sector in 2010, continued weakness in the North American natural gas market did not prevent the large producers from generating solid shareholder returns, with the median performance of the group nearly matching that of the entire survey. However, a high concentration of North American natural gas in the production mix detracted from returns, since U.S. natural gas spot prices, which began the year at what now seems like the lofty price of $6/MMBtu, ended the year at a nine-year low for the date, which was about 30 percent below where they began. This led to the denouement of Southwestern Energy, which had been a stellar performer in the previous three years, the report said.

"Natural gas inventories were well above average, and U.S. domestic production showed no signs of topping out," Gillon added. "Fortunately for everyone but the Europeans, it has been ferociously cold in Europe, so gas is being shipped to the higher priced markets. The world is well supplied with gas, and the modest upward slope to the current futures curve is testimony to the glut in supply."


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