STREET SENSE: Investing in Energy Stocks

Every investor should be aware of this key sector.

street sense
Investing in Energy Stocks
Every investor should be aware of this key sector.

If you hope to successfully invest in the stock market, you must understand the energy sector -- because a healthy economy depends on the availability of cheap and plentiful energy.

Go back to the early 1970s to see the havoc that soaring energy prices can wreak on the stock market. That's when OPEC first flexed its muscles, and what a tenfold jump in oil prices did to stocks wasn't pretty. The Dow Jones Industrial average lost almost half of its value in 2 years.

Almost 30 years later, the United States is again vulnerable to another energy shock. But this time it's not just the price of oil that worries us, it's also the lack of sufficient energy infrastructure to refine crude oil and turn it into usable fuels. There's also a critical need for more power plants to produce electricity.

As the Bush administration attempts to grapple with existing and potential energy shortages, investors should consider possible opportunities in this key sector. In this month's column, I'll provide a brief breakdown of some of the major areas for investment in energy:

  • Exploration and production. Companies involved in what the energy industry calls E&P basically make big bets on their ability to find oil and natural gas. Though some E&P companies will take bigger risks than others, E&P is the modern-day version of wildcatting. Invest in these companies and you can expect a bumpy ride. This area of the market isn't for those who are looking for steady dividends and a safe return. The good news for investors is that new exploration and drilling techniques have increased the success ratio for the E&P outfits. Examples of E&P companies are Anadarko and Apache.
  • Oil refining. No new oil refineries have been built in the United States in more than 25 years, which makes existing refineries very valuable. The major refiners have recently been busily gobbling up smaller refining companies at premium prices, making shareholders of the acquired companies exceedingly happy. This trend will probably continue, as large refiners like Valero grow through acquisition. This is an area investors should watch with interest.
  • Integrated oil companies. The largest energy companies, including such household names as ExxonMobil and Chevron, do it all. They explore for oil and natural gas on a massive scale, refine crude oil into fuel products, and market at the wholesale and retail levels. Their size and diversity makes the major integrated oil companies the safest investments in the energy universe.
  • Oil services. Hundreds of publicly owned companies provide services to the oil industry. From supplying workboats to drill bits, these companies play a role in the search for energy. These firms generally do well when exploration activity is high, as it is now, but their fortunes can go from boom to bust quickly. Examples of oil service companies are Schlumberger, Halliburton and Baker Hughes.
  • Construction. It's also important to remember that the need for energy infrastructure creates opportunities for construction companies that specialize in building power plants and refineries. Fluor and Foster Wheeler are leaders here.

A sector with many choices

Whatever your tolerance for risk, the energy sector offers companies that can fit into your portfolio. But be sure to do your homework before you invest. 

Jerry Helzner has written more than 50 articles on stock investing for Barron's. He has been a regular stock market columnist for other business publications and was a member of the equity research department of a major regional brokerage firm. He's also an associate editor for our sister publication, Ophthalmology Management.