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2013 Oil Outlook: Four Stocks Pumping Profits

After starting 2012 at $102 a barrel, West Texas Intermediate (WTI) crude fell as low as $82 in June before bouncing back up to close out the year at about $92.

That means oil prices suffered their first annual decline since 2008, when markets were walloped by the financial crisis. And that trend is likely to continue in 2013.

The reason is largely fundamental: Supplies are increasing and demand is poised to remain sluggish as the global economy continues to wheeze.

Supply Surge

Already, new North American shale production and sluggish U.S. demand have created a glut of WTI crude.

Inventories at Cushing, Oklahoma surged by about 30 million barrels – or 66% – in 2012, rising to about 50 million barrels of oil. And that surplus will persist as shale oil production rises and demand stays weak.

Meanwhile, the Organization of Petroleum Exporting Countries (OPEC) said on December 12 that it would leave its oil production target untouched at 30 million barrels per day (bpd).

So, as it stands now, the market is well supplied with crude. And that will continue to weigh on oil prices going forward.

Of course, that doesn’t necessarily mean we’re going to see a collapse in oil prices. It just means oil prices are likely to trade near the bottom end of their current range – around $80 to $85 a barrel – until demand accelerates or supplies shrink.

To that end, Iran – which is currently the subject of drastic Western sanctions – remains a major focal point.

A “Strait” Shot to $200 Oil

Iran’s oil exports tumbled 50% last year, while production at one point slipped to 2.65 million bpd – the lowest level since February 1990. Formerly OPEC’s second-biggest producer after Saudi Arabia, Iran has now dropped to fifth place in that group.

Sanctions have now undermined Iran’s economy to the extent that hyperinflation and job losses are taking a severe toll. Yet it’s unlikely that Iran will cave to Western pressure and abandon its nuclear program. So the standoff will probably persist for some time.

The situation is volatile and hard to predict. Many resolutions are possible, including the collapse of Iran’s government, or even the country completing the construction of a nuclear missile. Iran could also follow through on its threats to close the Strait of Hormuz, the vital artery through which one-fifth of the world’s oil shipments pass.

If Iran closes the strait, crude oil prices could pop by $30 to $40 a barrel within hours. Should the strait remain closed for 72 hours, oil prices could shoot to $180 in New York and $200 in Europe.

That uncertainty has been one of the biggest factors keeping oil prices afloat.

Higher production costs are another.

The Price of Production

The development of shale oil has been transformative for sure, but it’s come at a high price. It’s simply more expensive than sucking oil out of the sands of Saudi Arabia.

Energy consultancy firm JBC estimates that the costs of exploring and producing oil from the newest and most expensive wells now amounts to more than $100 a barrel. Compare that to $50 to $70 a barrel before the financial crisis and $20 a barrel a decade ago.

So if oil slumps down to the $70-to-$80-a-barrel range for an extended period of time, work on many of the more costly reserves would stop and production would decline.

These two factors – high production costs and Iran’s belligerence – are what will keep oil prices from caving until the Chinese and U.S. economies get out of second gear.

The Best Oil Plays of 2013

With oil stuck in a holding pattern and huge clouds of uncertainty casting a heavy shadow over the global economy, oil futures remain a risky play. But there are still plenty of profit opportunities to be had – especially in the pipeline segment.

What makes pipeline operators particularly attractive is that they’re basically immune to oil price fluctuations. They get paid by volume, so the price of the product they transport is of little consequence.

And with U.S. oil production expected to reach 7.1 million barrels per day in 2013 and 11 million barrels per day in 2019, business is booming for the country’s pipeline network.

So two companies you might consider are Kinder Morgan Inc. (KMI) and Energy Transfer Equity (ETE).

KMI is a standard corporation, but its assets include the general partner interests of Kinder Morgan Energy Partners (KMP), which is one of the world’s biggest pipeline companies.

And last year, it acquired El Paso Pipeline Partners, giving it access to key natural gas development sites and making it the country’s third-largest energy company.

Better still, the stock currently yields about 4%.

ETE is another good pipeline prospect. However, unlike KMI, it’s a master limited partnership (MLP). That means it isn’t taxed at the corporate level. Money is only taxed when shareholders receive dividends. (So make sure to consult your tax advisor if you choose to buy in.)

ETE has been on a shopping spree. The company recently acquired Southern Union Group for $3.7 billion, putting it in control of more than 44,000 miles of gas pipeline, capable of carrying 30.7 billion cubic feet of gas per day – almost half of the average daily U.S. consumption.

And that’s not all. ETE scored another coup last year, when its subsidiary, Energy Transfer Partners LP (ETP), acquired Sunoco Inc.

Sunoco Inc., of course, has a stake in Sunoco Logistics Partners, handing ETE a piece of the company’s lucrative midstream assets.

That said, there are still a few upstream companies in line for a blowout year.

Namely BP plc (BP) and Transocean Ltd. (RIG).

We’ve already evaluated both of these companies at length. (See here and here for in-depth analyses.) But the long and short of it is this…

For two companies responsible for one of the biggest ecological disasters in history, both BP and Transocean are in remarkably good standing.

Transocean has made the most of higher demand, building up a $31-billion backlog of rigs to be leased out to explorers.

And it’s still hard at work in the Gulf of Mexico, where the Macondo disaster took place. Transocean currently has 16 rigs operating in the region, which has seen its total rig count surge 25% year-over-year.

We predicted a surge in Transocean shares in December, and they’re already up 17% this month.

BP is on the comeback trail, as well.

Since the Gulf spill, BP has:

  • Raised $42 billion through divestitures.
  • Doubled down on its most profitable projects.
  • Posted outstanding earnings.
  • Raised its dividend.
  • And solved most of its legal problems, settling criminal charges with the Justice Department late last year.

Better still, the company boosted its dividend by 12.5% in the third quarter of 2012. It now pays $0.54 a share, good for a yield of more than 5%. And it’s committed to buying back shares to prevent dilution.

If BP manages to shake off the last of its legal troubles this year, it won’t be long before the stock returns to its pre-crisis level of about $60 a share. That would be a 50% increase from where it’s currently trading.

So keep an eye on these four companies. They’re likely to excel regardless of the direction oil prices go.

And “the chase” continues,

Jason Simpkins

Jason Simpkins

, Energy Editor

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