Projecting Oil's Course When Calm Is Restored

<a href=www.nytimes.com>Web MARKET INSIGHT By KENNETH N. GILPIN

OIL prices have fluctuated wildly in recent weeks. They bumped up against $40 a barrel on Feb. 27 but now stand at around $30.

Frederick P. Leuffer, senior energy analyst at Bear Stearns, talked last week about the effects of the Iraq war on oil supplies and the direction of oil prices — as well as the implications for big international oil companies. Following are excerpts from the conversation:

Q. In the last 12 months, there have been major oil supply disruptions in Iraq, Venezuela and Nigeria. How does the current situation compare with that of the Persian Gulf war?

A. There are a lot of differences between now and 1990-1991, but there are a lot of similarities. In 1991, we lost up to 5 million barrels a day from Iraq and Kuwait combined. Iraqi production now is about 2.3 million to 2.5 million barrels. Before the strike, Venezuelan production peaked at about 3 million barrels. Now, they are back up to just over 2.4 million. And the drain from Nigeria is about 800,000. But not everybody has been out at the same time.

Q. Based on what we know now about conditions in Iraqi oil fields, how high could production go after the war?

A. If the war goes well and the northern fields, which represent about half their production, are not damaged, it is conceivable you could see Iraq producing 2.5 million to 3 million barrels a day within a month after the end of the war.

Q. Will falling oil prices be enough to increase global demand for oil?

A. We are estimating world demand growth at 2 percent this year, but only because we expect crude oil prices to fall sharply. If oil prices are sticky in the high $20-a-barrel range or low $30's, I expect the economy will not do so well, and that demand will be tempered.

Q. Do you expect gasoline prices to rise more this summer?

A. I think gasoline prices are likely to be pretty high, but maybe not as high as they are right now. There is sufficient gasoline-making capacity, and unless there is an unexpected event at refineries, we won't see shortages, and prices will come off current levels.

Q. How have big oil companies reacted to developments over the past year?

A. Exploration budgets haven't moved up very much, which may show better discipline on the part of the companies. Skepticism is very high that spot oil prices will be $25 a barrel, let alone $35 or $40. They tend to base their exploration budgets on prices of around $18 a barrel. And they are using this windfall as an opportunity to pay down debt.

Q. Why haven't shares of big oil companies performed well in recent months?

A. Ever since oil went through $25 a barrel midway through last year, oil stocks have underperformed the market. But the Standard & Poor's integrated oil index is yielding about 3 percent right now, which suggests there is probably not a lot of downside risk in the stocks. But I think they will be left behind in a rising stock market, which in part will be driven higher by a drop in oil prices. That is what happened in 1991.

Back then, the Standard & Poor's 500 index was up 26 percent for the full year. The S.& P. oil composite index was up only 4 percent. The groups that will do well in the next rally will be the heavy users of oil, not the companies that produce it.

Q. Is there a case to be made for holding oil company shares in a diversified portfolio?

A. There is something to be said for holding some oil shares all the time. Over the last 20 years, Royal Dutch/Shell and Exxon Mobil have outperformed the S.& P. 500, so a buy-and-hold strategy for high-quality companies has rewarded investors.

Q. Even though you expect oil prices to fall sharply, there are still a couple of stocks that you like. Could you talk about them?

A. BP is my top pick right now. It is yielding close to 4 percent, they have raised the dividend three times in the last year and they are in the midst of a $2 billion share repurchase program. Also, they will grow oil and gas production between 4 percent and 5 percent a year over the next five years. I don't expect a lot of downside risk.

Royal Dutch/Shell is much the same story, but with a bit higher dividend yield. The stock took a hit when it was taken out of the S.& P. 500 index as part of a decision to eliminate foreign stocks. But we see decent growth for this company, and I would expect they will continue to raise the dividend. For the last 14 years, they have increased dividend payouts twice a year.

We also like ChevronTexaco. The stock has been under a lot of pressure because it has posted disappointing earnings in three of the last four quarters. But statistically it is very, very cheap. If they can get more aggressive on cost cutting, the stock is undervalued.