Are oil stocks oversold?

by Addison Wiggin & Ian Mathias

  • Oil stocks get slammed… Byron King on whether the sector has become oversold

  • Regulation blowback: How the recent offshore drilling ban will likely do more harm than good

  • Heirs to the throne: Unemployment rate among teenagers and college grads soars

  • Plus, tales from the front lines: Armchair economists, former Big Oil employee write The 5

 

  Sweaty hand-wringing over U.S. stocks continues. The S&P fell another 1% and change yesterday.

  Of course, leading the market down, yet again, was everyone’s favorite oil stock British Petroleum (BP). Indeed, uncertainty is the order of the day… how big is the spill, when will it be capped, how much will it cost? The company said yesterday it has already spent $1 billion on cleanup.

What about legal issues? There are already 26,000 claims against BP on the docket, including 150 lawsuits.

Add to that, the U.S. attorney general announced his own civil and criminal investigations into the spill. That announcement, along with the weekend failure of “top kill,” bumped BP shares down 15% yesterday.

Since the spill, BP has seen its market cap chopped by $75 billion –– one-third of its market value.

  President Obama also announced a moratorium on all deep-water drilling projects. The ban, as you might imagine, is not only a dollar short and a day late… but also bad policy.

“Let's look at the immediate impact on the Gulf of Mexico energy industry,” our Byron King suggests, “Every drilling project costs in the range of $500,000-$1 million per day. Close down dozens of these projects all at once, and you'll witness an instant drought of funds in the energy economy. Indeed, it's an overnight drilling depression.

“That day rate and other overhead cost for a drilling project are not just ‘Monopoly money.’ Each drilling project supplies direct employment to several hundred workers and technical staff, as well as indirect employment to hundreds more in the service industries…

“I expect that we'll see a slew of players — operators, drilling contractors, service companies and vendors — declaring force majeure in the coming weeks. Some firms will attempt to get out of burdensome clauses that require them to perform and/or pay, during a time when no one can work due to the government moratorium. Typically, however, the drilling contracts provide contractors some protection. It'll create work for the lawyers — at least the ones who aren't already busy suing BP.

“It's plenty bad that the fishing and tourism economy of the Gulf region is hurting because of the BP oil spill. There are entire arcs of personal hardship just from that alone.

“Now we can watch, over the coming weeks and months, as energy workers lose their jobs. This includes engineers who make $150,000 per year, rig workers who take home $75,000, all the way down to dockworkers making $10 per hour loading sacks of cement on flat-back boats. Oh, and the boat owners? They may not make their payments to the bank, either.”

  BP is not alone. Transocean, Halliburton and Cameron — each linked to the disaster — fell double digits yesterday. But it didn’t stop there. Offshore drillers with no stake in Deepwater Horizon are getting pummeled, too. The herd fears the moratorium will become politically popular… and, therefore, permanent.

At the end of the day, the sell-off creates a buying opportunity. Oil and oil service stocks are now “way oversold,” maintains Mr. King. “Unless, that is, people are going to give up using oil.” That’s not to say all oil service companies are “buys.” Find out Byron’s favorites, right here.

  Hedge funds as a class just had their worst month since the Lehman collapse in May. After pocketing their 2% fees (and relinquishing their 20% profit share), the average hedge fund turned in a 2.7% loss last month.

Even the now infamous Abacus inventor, John Paulson, lost 7% through May 20. His fund is down 3.3% for the year thus far.

  For the rest of the week, traders will be fretting over American jobs too. ADP will report its best guess at May private sector numbers tomorrow. Then Uncle Sam will fudge some employment numbers of his own on Friday.

Ahead of that noise, we offer this chart. As we’ve said many times before, there are few things more dangerous than growing masses of jobless young men. Despite the headline unemployment number stabilizing, their ranks continue to grow.

The “official” unemployment rate of those aged 16-24 was 19.6% in April. That’s double the headline national average. Oh, the hard math of demography! The very workers who are supposed to be paying into the pay-go retirement system can’t find work…

  A few renewed contrarian opportunities arose for our Trade of the Decade this morning. A falling stock market and continued uncertainty in Spain, Greece and Italy have pushed U.S. Treasury bond yields down to 3.3%. That’s not the lowest they have ever been, but historically speaking, low enough to sell.

And on the other side of the Trade, there’s “blood in the streets” in Japan. Prime Minister Hatoyama announced his resignation today — the seventh Japanese leader to do so in the last 10 years. What a mess.

We still don’t know what’s in store for Japan. No one does, in fact, which is why the “smart money” won’t touch it with a 10-foot pole… like gold in the ’90s.

  Five U.S. banks failed last week, bringing the 2010 body count to 78. Three in Florida, one in California and another in Nevada will cost the FDIC fund another $317 million. The “fund” is now over $21 billion in the red.

But a bit of a celebration is in order. Our friends at EverBank scooped up most of the failed Florida banks Friday, acquiring some $1.2 billion in deposits and $1.3 billion in loans and assets.

(Tip of the chapeau to Frank Trotter, Chuck Butler and Chris Gaffney, the EverBankers you often read here in The 5. Not only have they survived through the credit crisis, they’re thriving in it.)

  The Bank of Canada became the first G-7 central bank to raise interest rates since the onset of the global credit crunch this morning. The Canucks bumped their rates up 25 points, to a still ultra-cheap 0.5%.

The rate hike came on the heels of the best Canadian GDP reading in a decade. The resource-rich economy grew at an annualized 6.1% in the first quarter, well ahead of estimates.

  Pending home sales rose 7.1% in April, to a six-month high, the National Association of Realtors (NAR) says today. May’s tax-credit free numbers come out in about four weeks.

  The horrifically lousy subprime security ratings that led to the market collapse of 2008 was “deeply disappointing,” Moody’s CEO Ray McDaniel testified before Congress today. The powers that be are rounding up executives from the “big three” ratings agencies for a hearing today, along with one of their most prominent investors — Warren Buffett. What he says will likely be the only thing interesting. Either he admits the truth and sabotages his massive stake in Moody’s or attempts to maintain the status quo… and becomes just another Wall Street fool.

 

Either way, as we note in the latest issue of Apogee Advisory, despite all the obvious, common-sense issues — incompetence, conflict of interest, past performance — the mighty financial reform bill circulating the halls of Congress barely addresses the ratings agencies.

 

The task of reforming agencies seems of such small importance that it’s been left to junior Sen. Al Franken. His proposed amendment to the financial reform bill would do this (according to a blog referenced on Franken’s website):

 

“It would allow the SEC to set up a self-regulatory organization (that is, one not created by Congress) called the Credit Rating Agency Board. The CRAB, made up of investors as well as independent regulators, would then create a roster of qualified rating agencies, and select a method of assigning initial ratings on securities to those agencies. The amendment would encourage randomization, but not mandate it.”

 

That oughta make things a lot more transparent.

 

Even the free market seems to have failed in this instance. There are more than just three ratings agencies in this world, after all. Some of them even managed to do their jobs… “second tier” agency Egan-Jones comes to mind. It is paid by the buyers of the securities it rates, not the issuers… what a novel idea! Yet Egan-Jones is not the No. 1 agency in the world, for reasons we can’t explain.

  Gold’s down just a few bucks today, to around $1,220.

  “I wonder if the fellow ever gave a thought to where the steel, aluminum and rubber came from to make his damn bicycle?” a reader lashes out at our smug bike rider from Michigan, “Maybe it just materialized out of thin air!

“All the products that make our lives worth living come to us via diesel engines. From the diesel-powered farm tractors that help grow our food to the diesel trucks that haul all the raw goods to the evil manufactures to be made into evil products. Then the evil truckers can haul the products to the evil wholesalers, who then truck it to the evil retailers, who then sell it to us evil consumers, who then take it home in our evil gas-guzzling SUVs.

“Tell that clown we don't want to live in caves and eat our meat raw or wait four months for a head of lettuce to get from California to New York via a bicycle.

“We have discovered fire and the wheel and are not looking back.”

 

The 5: You could grow the lettuce yourself.

  “Functionally, profits can’t be obscene!” another answers the same gentleman on a different tangent. “They can only be legal or illegal, as defined by the local society and codified as laws. They can be good, as in a good return on investment or bad as in a bad return. Profitability is — or should be — a measure of how well a company performs, how well it is run either by its owners or by their hired guns.

“In the short term, smart companies do not seek maximum profits, but, rather, optimum profits. They don’t rape their future earnings (and future) to make today’s earnings look good. If they do, astute owners find new hired guns to run the company.

“When companies get away with illegal activities, the real culprits are the regulatory agencies that did a poor job. Bottom line is that if ‘voters’ in democratic forms of government and in corporations are willing to accept poor performance from their hired guns, then they are getting what they deserve.”

  “I've worked in Big Oil for 22 years,” a third writes, with an inside look at the disaster BP has become. “I've worked for two of the Big Five and consulted for a dozen other majors around the world. Most of them are fanatical about safety. ConocoPhillips facilities are plastered with posters quoting the CEO: ‘There's nothing we do that is so urgent or so important that we can't take time to do it safely.’ Exxon is even more fanatical.

“It’s a risky business. Safety costs money (sometimes lots of money) in the short run — but it saves money in the long run. Management must strongly believe that and constantly hammer the message to build a safety culture in an organization. Results are proven, and industry safety records over the past 20 years show phenomenal improvements in reducing accidents and injuries.

 

“I have no firsthand knowledge of BP, but I have several friends who do — and they refuse to work for BP because of a reputation of willingness to cut corners on safety. I know one 30-year senior manager who quit when his employer was taken over by BP because he refused to work for a company he considered unethical. In this business, putting peoples' lives at risk unnecessarily is considered more unethical than falsifying numbers on your balance sheet.

 

“In the last couple of years, there have been several loss-of-life incidents at BP facilities that ‘smelled’ of safety shortcuts. Legal investigations may identify local managers who ignored problems or authorized shortcuts, but I place the blame on the executive suite for failure to build and maintain a culture that puts safety first.

“I have no problem throwing them in jail if criminal actions or negligence can be proven. If not, the board of directors should fire a few executives as examples — just to kick-start the need for culture change. If punitive fines destroy the company, the assets will be taken over by other companies that will run them more safely. Burned stockholders will learn to screen company safety records before buying stock.”

The 5: If Eric Holder has any say in it… you may get your wish.

Cheers,

Addison Wiggin

The 5 Min. Forecast

P.S. Have you ever heard the story of why we left Wall Street? We had a memorable stint there… one that still offers opportunity to our readers today. Allow us to elaborate, here.

rspertzel

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