Energy Stocks

Natural gas and oil prices have continued their steady increase. Unlike oil shortages in the past that were in large part politically driven, world-wide demand for energy has driven long-term commodity oil prices over $60 a barrel. Oil prices are not likely to come down significantly in the near future.

Since traditional NAIC analysis focuses on earnings growth, it does not work particularly well with energy stocks. The value of an oil or natural gas company depends in large part on the value of the company’s reserves. Proven reserves are the real assets. Kurt Wulff of McDep Associates evaluates and ranks energy stocks based on the value of their reserves. He also computes several other ratios that are helpful in comparing oil and gas producers.

Using information about a company’s reserves, Wulff calculates a “McDep ratio” for each company. A McDep ratio of 1.00 represents a present value that assumes a long-term oil price of $40 per barrel. Companies with a McDep ratio less then 1.00 are undervalued (assuming future prices return to $40 per barrel). They are very undervalued if long term oil prices remain above $40 per barrel.

We currently own one oil stock, Chevron (CVX). It is classified as mega cap company and represents 3.8% of our portfolio. It has appreciated 10.9% since we bought it earlier this year and it pays a 3.1% dividend. We should consider increasing our energy-related holdings, perhaps owning one or two producer/refiners or independent producers. The current edition of McDep Associates’ weekly newsletter, the Meter Reader, ranks oil and gas producers using the McDep ratio. Lukoil Oil Company (LUKOY), Anadarko Petroleum Corp. (APC) and Encore Acquisition Company (EAC) have the lowest McDep ratios in their respective industry categories.

Give some thought to adding energy holdings to the portfolio in the near future. Owning some stocks with proven energy reserves, especially ones that pay a dividend, seems like a prudent investment.