Betting on big oil's comeback

The price of crude is nowhere near its summer highs, but analysts say that means it's bargain time.

By Mina Kimes, reporter

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NEW YORK (Fortune) -- With crude down below $45 a barrel, it's hard to see the beauty in oil stocks these days. But with analysts forecasting a rebound in prices, now might be a good time to buy.

"Right now, the upsides in the oil sector far exceed the downside risks," says Fadel Gheit, an analyst at Oppenheimer & Co. "I am absolutely convinced that oil prices will rise."

After last year's $100 free-fall rocked expectations, that kind of confidence is surprising. But Gheit is not alone; a strong consensus is growing for a price rebound. While crude isn't likely to rocket back to the sky-high levels of 2008, even bearish analysts admit that oil can't stay below $50 for long.

As demand and prices drop, producers are drastically cutting back on spending, and OPEC is moving quickly to cut supply. The market is currently over-saturated, but when the commodities market sniffs out the coming deficit, prices will rise again, say analysts.

"We see oil consumption in 2010 being close to what it is in 2009, but production will be down," says Ed Maran, the co-portfolio manager of Thornburg Value Fund. "There's a potential for a shortage in 2011, and it's entirely possible that we could be back up to $100 oil."

Maran thinks demand will return when the global economy recovers, led by oil-hungry countries like China and India. The industry faces political headwinds from the new administration, but few analysts believe that alternative options will satiate the demand for energy in the near future.

Exxon: a league of its own

Exxon Mobil (XOM, Fortune 500), the world's largest oil and gas producer, stands to benefit if prices rise, but it is also unlikely to suffer much if they don't climb in the near term. "If the economy recovers but oil prices don't exceed $60 -that's the perfect environment for Exxon Mobil," says Gheit. While other companies need higher prices to boost profits, Exxon can reap the benefits of a smaller boost.

Some analysts don't like Exxon's limited upside. Because of the company's massive market cap, it will only react so much to rising prices. Goldman Sachs' Arjun Murti compared it to U.S. Treasuries because of both securities' perceived safety.

"You won't see a lot downs - or ups - because Exxon is so widely held and has such diverse operations," says Allan Good, a Morningstar analyst. "If oil shoots back up, Exxon isn't the best company to take advantage of the upside."

At an analyst presentation on Thursday, Exxon said it plans to boost its spending to $29 billion in 2009. CEO Rex Tillerson highlighted the company's exploratory potential, but Gheit read something else between the lines. "They're going to make a large acquisition," he says. "It's going to happen soon."

As the valuations of smaller companies drop, Gheit says Exxon could scoop up another producer at great discount. The company has enough money to buy any of its competitors - in combination - but would likely face regulatory opposition if went after another large producer.

Until then, Good says investors can take comfort in Exxon's $31 billion in cash. "Park your money there and get a nice return off of the dividend." The company is expected to raise its dividend soon to compete with companies like BP (BP), which currently offers a whopping 9.5% yield.

Opportunities across the board

Other large stocks stand ready for a rebound. ConocoPhillips (COP, Fortune 500), whose shares have fallen 57% over the last year, has a price to earnings ratio of 9 versus Exxon's 13. The company has a large amount of refining exposure, which hurt its bottom line in 2008 because of rising oil prices and slowing consumption.

Maran says that ConocoPhillips was unfairly penalized because of its partnership with Lukoil and its expulsion from Venezuela. Investors are worried about political risk - an overreaction, he says, and one that's likely to change if more countries invite foreign companies in to revive their flailing economies.

Another big producer analysts say is undervalued is Petrobras (PBR), which discovered a series of mega-fields off of the Brazilian coast two years ago. Goldman's Murti recently wrote that Petrobras "may be the best positioned major oil company in the world for the next oil price upcycle."

It's still unclear how much the company's offshore find is worth, but Don Coxe, a longtime oil guru who now runs Coxe Advisors, likes what he sees. "Petrobras is a special story, and investors want to be a part of it," he says. "They could find $25 billion worth of oil down there."

For investors who are willing to dip their toes into less familiar territory, a variety of small, "beta" oil stocks could pop if prices go up. Gheit prefers Anadarko (APC, Fortune 500) and Devon Energy (DVN, Fortune 500) for their strong exploration portfolios. While it's not wise to bet on acquisitions, he warns, they could be targets for companies like Exxon - when prices are this good, retail investors aren't the only ones eyeing oil stocks. To top of page

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