Ben Stein Defends Energy Stocks

In The New York Times, Ben Stein stands up energy stocks. He says that the surge in oil stocks shouldn’t be compared to the Internet bubble of a few years ago.

With the greatest respect for my fellow seers, there are a few things desperately wrong with the analogy—and with this whole line of reasoning.
First and foremost, Internet stocks largely had no or negligible earnings. They were valued on hype and rumor. They were not traditional securities with earnings and dividends. They had no value except their trading value. When they did have profits, they often sold at 100 or more times those earnings.
On the contrary, oil and gas stocks have had spectacular earnings. Take a look at those of Exxon Mobil,BP or Valero. Those stocks’ price-to-earnings ratios are far below, not above, the ratios for the S.& P. 500-stock index as a whole. Take a look at the royalty trusts like those for Prudhoe Bay on the North Slope of Alaska and the Permian Basin in west Texas. The P/E ratios for these trusts – vehicles that energy companies created to transfer interests in their properties directly to their stockholders, who became unit holders in the trusts – are also far lower than even the P/E ratio of the blue-chip Dow Jones industrial average.
And it’s important to remember that these ratios are for the last quarter, before the spectacular hurricane-related price increases for the products they sell. It’s entirely possible that their earnings will rise, not fall, at least in the short run, as the storm-related prices take some space on their books. (Of course, they will also have costs to repair their facilities, but those costs can be spread out over years.)
Generally speaking, there is a bubble in a security or an asset if its price rises faster than its earnings. Hence the bubble in Internet stocks, which often had no earnings, and perhaps now in residential property, as prices rise faster than imputed rent. But if a security rises quickly in price because its earnings and prospective earnings also rise quickly – where’s the bubble?

I think this is a bit of a straw man argument. While the flimsiest Internet stocks crashed and burned, so did many tech stocks with real earnings. Stocks like Cisco, Microsoft and Dell all saw their stocks plunge. These stocks shouldn’t be compared to the likes of TheGlobe.com. Cisco, for example, did have a bloated P/E ratio, but it also delivered amazing earnings growth quarter-after-quarter for several years.
The lower earnings multiples for energy stocks is not a sign of good value, it’s really a sign that these are cyclical stocks, and the market sees the end of the cycle coming soon. Instead of comparing energy stocks of today, with Internet stocks of few years ago, we should compare them to energy stocks of 15 and 25 years ago. My fear is that the problem isn’t bloated energy stocks, but bloated energy prices.

But some people say energy prices are in a bubble themselves. Maybe yes and maybe no. Certainly, when oil and gas and electricity production resumes along the Gulf Coast, one would expect energy prices to fall. I am positive that they will fall, and indeed they have already started to fall. But let’s remember that these are world prices. What has been taken off line in Louisiana and Texas is a lot of United States production but only a small fraction of world production. What has moved the price so much this year is the global imbalance of supply and demand.
Yes, prices reflect storm damage and storm-related scarcity to some extent. No doubt about that. But the prices, which were already rising before the storms, have now retreated to pre-Katrina levels (at least for oil, if not natural gas) and may have already passed through the storm bubble and come out on the other side.
There is a real problem in energy commodities as far as consumers are concerned. We are using energy a lot faster than we find it. As I have written before, price is how we allocate energy products when demand is rising faster than supply, or vice versa. We are seeing the world’s people start to suck the oil from the earth at a particularly breathtaking rate.

The problem is that the price of oil has been falling since the hurricanes, not due to the hurricanes. The market’s reaction has been to undue its previous overreaction. All energy bubbles begin differently, but they all end the same way.

In the meantime, the integrated major oil companies, refiners and royalty trusts own a great deal of a commodity that is rapidly disappearing and is rapidly rising in price. As oil companies drain their reserves faster than they find new ones, their P/E ratios may fall to levels usually associated with royalty trusts, but they will still own a supervaluable asset.

Higher prices won’t translate into higher profits if there is indeed a failing supply. A diminishing supply will ultimately mean lower revenue for everyone.
IT used to be that oil prices could be punctured on a moment’s notice. Just ask Midland, Tex., which suffered greatly in the oil bust of the 1980’s after Saudi Arabia raised its output a few notches. Oil prices are already correcting in the short run. But there is a real question now as to whether the Saudis can raise output in a meaningful way, and no one else seems to have a lot of spare capacity. Add to that the fact that a lot of the world’s oil producers don’t like us much (a subject for a future column). That is very good news for Midland.

The U.S. economy is far more resilient to higher energy prices than it used to be. So far, we’ve able to absorb this “energy shock” to our system without hurting the consumer. This may soon change, but as of yet, there’s no compelling evidence.
The real story of our new foreign policy is that, far from being obsessed with oil, we’re finally not kowtowing to energy-producing countries. We no longer have to.

Does this mean that energy stock prices will not correct in the short run? Without question they will correct. Stocks usually correct in the short run after an immense climb.
But are we in a bubble of energy stocks as bubbles are usually defined? No, and the long-term future for entities that own a great deal of a commodity that they bought cheaply – many of the majors have billions of barrels that cost them well under $10 a barrel – and that may stay in desperately short supply looks pretty good to me.
Would I bet the ranch on it? No, but then I don’t own a ranch. I may bet a cow, although I don’t own a cow, either.

But what will energy stocks do with all their profits? It doesn’t just disappear. All that surplus profit will be reinvested in new technologies and greater efficiency that will, over time, lower the price of energy.

Posted by on October 9th, 2005 at 4:32 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.