Black Gold: Energy Funds Spout Profits for Investors

The value of energy-sector mutual funds burst skyward this year like an oil-patch gusher, enabling investors to merely doff their hats and let the profits rain in.

The Standard & Poor's index of oil-well equipment and service stocks has soared 66 percent in the past year. In the same period Fidelity's Select Energy Service fund has returned 94 percent (800-544-8888).

Investors who have spotted the energy opportunity only recently might well ask, "Has the gusher played itself out?"

The answer: Yes and no.

Speculative flurry

Momentum equity investors and options traders in recent months have begun to swarm all over oil stocks. Volatility has jumped. The enthusiasm is a sure sign the appeal has less to do with bargain values than with speculation that stock prices and earnings will continue to rocket.

And investors shouldn't assume that all oil-related companies will boom like the service sector.

Fidelity's energy-service fund has been a big winner precisely because it focuses on equipment and services. Many analysts foresee a continued drilling boom ahead.

Still, oil prices are expected to fall in the next few months from the current $21 per barrel price, which could hurt profits of many companies in the oil sector.

"Demand from the Far East is slowing down as a result of economic problems and also the OPEC countries, especially Iraq, are putting a lot more oil in the market," says Phil Dodge, an energy analyst at Southeast Research in Boca Raton, Fla. He expects the price of oil to fall as much as 25 percent.

The likelihood of such a decline reinforces the opinion of analysts that the sector is due for a downward "correction" in stock prices sometime within the next six months.

"They have outperformed much of the general market and there is a good question of how much is left before we see a consolidation that would prepare us for the next big leg up," says George Gaspar, managing director of petroleum research at Robert W. Baird & Co. in Milwaukee.

Despite the short-term uncertainties, analysts agree that energy-sector mutual funds are a promising long-term play, worthy of at least 10 percent of an equity portfolio.

Big Oil and the many companies that service it emerged from the severe industry shake-out of the past decade well streamlined. The sector has cast off excess capacity and slashed inefficiencies across the board.

New technology, especially three-dimensional seismic exploration equipment, is enabling drillers to tap profitably into abandoned wells and boost their success rate on new fields.

"The sector is pushing the envelope with new technology, moving further and further out into deeper water, and their finding rate is improving," says Michael Hoover, manager of the Excelsior Energy & Natural Resources fund (up 29 percent year to date; 800-446-1012).

Growing demand for oil

Most important, many analysts believe strong global economic growth and rising demand will eventually push up the price of oil.

The inflation-adjusted price of oil today is about half that of 1985, largely because of conservation and expanded supply.

Strong worldwide demand - especially from Southeast Asia, Europe, and Latin America - will probably cause a classic supply/demand pinch and catapult the oil price, say analysts.

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