Energy stocks could be refined in 2009

Oil prices could bounce back, and then so will natural resources shares. Today’s price of oil represents the wise and sober assessment of all available information by all market participants.

Ahahaahaha! Just kidding. In reality, the price of oil reflects the fear that the world economy, as we know it, will fall into a kind of fiscal coma, followed by alternating periods of decrepitude and collapse.

Should the world economy move up from recession to normality, however, it’s a good bet that the price of oil will rise late next year – and that means, in turn, that energy stocks and natural resources funds will be the chief beneficiaries.

Natural resources funds have been pumping mud this year, falling an average 47.5 percent. Although the bear market is partly to blame, the collapse in oil prices is the main culprit, because resources funds invest primarily in energy stocks.

The price of a barrel of light, sweet Texas crude soared to $145.29 on July 3, up 51 percent from the start of 2008. Oil had soared more than 1,111 percent since 1998, when a barrel of oil cost about $12 – less than a case of beer.

But the oil gusher went dry. Oil for January delivery closed Thursday at $47.98 – up 10 percent for the day, but still 67 percent off its July highs. What happened?

Global financial collapse. Demand has plunged since July because of the economic slowdown. “Most driving is work-related,” says Tom Kloza, chief oil analyst for the Oil Price Information Service. You don’t drive as much when you’re laid off.

Because the recession is global, people in India and China aren’t driving as much, either. World economic growth could fall 2 percent or 3 percent in the coming year – which doesn’t sound like much but is enormous. “It’s like a 2- to 3-degree temperature drop for a human being,” Kloza says.

Some experts are getting bullish on oil, however, not because demand is rising, but because it’s not falling as fast as it was earlier in the year. “We might be seeing the worst on demand as we speak,” says Timothy Parker, energy analyst at T. Rowe Price.

Predictably, energy stocks have been clobbered – too much so, says Derek Rollingson, manager of ICON Energy fund. “They’re a tremendous value,” he says. He figures investors get about $1.80 in value for each dollar invested in energy now.

Dan Rice, manager of BlackRock Global Resources, thinks that current energy stock prices assume that oil will stay in the $40-to-$50 range forever. “If the global economy slows 3 percent to 4 percent for the foreseeable future, that might be correct,” he says. Should the world economy eventually recover to 2 percent to 3 percent growth, however, oil could hit $90. And already, the Organization of Petroleum Exporting Countries has started to cut production, which should prop up oil prices.

If you’re worried that the economy won’t recover, the safest bet is via the big diversified oil companies, such as ExxonMobil (ticker: XOM). But ICON’s Rollingson thinks Occidental Petroleum (OXY) is far more undervalued.

BlackRock’s Rice thinks that the smaller energy companies – many of which have fallen 80 percent or more in the energy rout – are worth a look. If the world economy revives, even to 1 percent annual economic growth, a basket of small, beaten-up energy stocks will fare far better than ExxonMobil. Of course, if the economy stagnates, these stocks will get clobbered, too.

For most investors, a basket of stocks is better than one or two individual holdings, and that means investing in a mutual fund. The funds with the best long-term records are in the chart.

You might also consider exchange traded funds, which you can buy and sell on exchanges, just like stocks. Most energy ETFs simply track an index, which means they operate at lower costs – and are immune to wrong guesses by portfolio managers. You shouldn’t bet more than 5 percent of your portfolio on energy: After all, if you own a diversified fund, you’ve probably got energy stocks there, too. But at these low levels, adding a bit of energy could help fuel your portfolio in 2009.