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Sector Watch: Oil Stocks Have Room for Gains, Analysts Say

The oil boom may be over, but analysts say there still are compelling reasons to invest in the energy sector.

After three years of strong gains, energy stocks are at “the early end of a multi-year bull run,” said John Kattar, chief investment officer at Eastern Investment Advisors. Energy is his favorite market segment heading into 2007, he said.

Rising oil prices sparked widespread gains throughout the sector in 2004 and 2005. However, this year, performance has been more mixed.

As oil prices fell from an all-time high of $78.40 in mid-July, investors placed their bets on dividend-paying oil giants such as Exxon Mobil and Chevron. These stocks have already had a good run.

So some analysts suggest going after the energy laggards.

These would include BP, whichtypically would have benefited from higher oil prices, but its shares are down for the year. The company has fallen out of favor after suffering through a series of missteps that have tarnished its image and placed it under intense scrutiny.

These incidents have ranged from a refinery explosion that killed 15 workers to a pipeline leak that caused the largest-ever onshore oil spill in Alaska.

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Playing Catch-Up

“This is a stock that could play catch-up with the group,” said Fadel Gheit, an analyst at Oppenheimer.

Gheit, who owns BP shares, said he expects the company to buy back its own stock in “a major way” next year, which typically boosts the price.

In addition, there continues to be speculation that a merger could be in the works between BP and rival Shell. This talk, which may have been sparked by the upcoming retirement of BP Chief Executive John Browne, surfaced several months ago, and was dismissed by the companies at that time.

Gheit also likes Murphy Oil, another integrated oil company--which means it produces and refines oil. Its stock has lagged the gains of the sector. He expects things to turn around as Murphy's production levels rise, by potentially as much as 80%, when an oil discovery in Malaysia comes onstream in the second half of next year.

Raymond James analyst Pavil Molchanov is looking at a number of companies with the potential to substantially increase the size of their production and reserves without making acquisitions.

His top picks include companies such as Ultra Petroleum, Chesapeake Energy, Comstock Resources, CNX Gas, and Goodrich Petroleum.

“Ultra Petroleum has some of the best fundamentals anywhere in the E&P industry,” Molchanov said. “It has an asset base of low-risk, high-rate-of-return prospects and … it benefits from one of the lowest cost structures of any E&P natural-gas-focused company in the U.S.,” he said.

If Ultra shares reach Molchanov’s 12-month price target of $88, the stock will have gained more than 80%.

More Capital Spending

Oil companies are once again expecting to spend higher amounts on exploration and production next year. If this holds true, it will be the eighth-straight year of increases in the sector, or the longest run of higher spending on oilfield services in more than 25 years. This is good news for the companies that supply oilfield services.

“We recommend investors focus on companies with a strong operating track record, a history of innovation, and an established international market position,” Citigroup analyst Geoff Kieburtz said. His top picks are companies such as National Oilwell Varco as well as those who service international and deepwater programs, which are more likely to be sustained or increased if macroeconomic conditions weaken. These companies include Halliburton and Schlumberger.

Kieburtz doesn’t own any of these stocks, but Citigroup owns at least 2% of Halliburton and the firm has managed offerings of fixed-income securities for all three companies.

If the thought of picking through the Oil Patch seems daunting, another way to play the group is through exchange-traded funds, said David Kotok, chief investment officer at Cumberland Advisors.

Cumberland has an overweight position on energy sector heading into the new year. Kotok’s favorite pick is the Vanguard Energy ETF, which is the broadest of the energy-based ETFs with more than 100 energy companies in the fund.

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