Energy sector charges ahead of the market

Oil may be sticky, "gucky" stuff, but for investors and mutual-fund managers, it is suddenly pure gold.

Ditto natural gas. Yes, lest anyone hasn't noticed, there's money to be made from scores of down-to-earth firms that extract, refine, service, and distribute energy-related products.

Just ask John Segner, manager of the red-hot INVESCO Energy Fund, based in Denver. Mr. Segner's fund, one of the top-ranked energy funds in the US this year, is up 40.8 percent since Jan. 1. (See chart below.) That is occurring in a market when most stock funds are either barely holding their own or turning in negative numbers.

Segner cites three reasons the energy sector will continue to grow over the long term:

* The global community is using energy commodities, such as oil and gas, at very high levels.

* "Capacity is tight." There is little or no surplus product available for the market right now.

* "Nothing is replacing either oil or natural gas as the energy product of choice. Alternative energy sources," whether fuel cells or power generated by windmills, for example, "are really just science projects at this point," he says.

Little wonder then that the energy sector has been on a tear of late. The sector, which includes some 64 stock funds, is up 15.4 percent through Oct. 31, according to information firm Morningstar Inc., in Chicago. By contrast, the Standard & Poor's 500 Index, which comprises most large Fortune 500 companies in the US, is down 4 percent through that same period. The Wilshire 5000 Index, which measures the total US stock market, is down 3.6 percent through Oct. 31.

Mr. Segner, who has been at the helm of his fund since 1997, says continued high demand will shore up both crude oil and natural-gas prices well into the decade. Even if crude-oil prices fell from the current highs of more than $30 per barrel, they would still remain higher than last year, when prices hovered around $20 per barrel, he says.

Moreover, natural-gas prices are "at their highest levels in recent memory," he says, driven in part by electric-utility demand. "Virtually every new electric-power plant under construction uses natural gas" to generate electricity, he says.

Demand for electricity is also coming from new and somewhat unexpected sources. "The Internet uses 8 percent of all electricity output in the United States," Segner says. Guess what? The Internet continues to expand, both domestically and globally. "Personal computers use 13 percent of all electricity," he adds, so the very structure of the New Economy should boost the importance of the older energy sector.

The flip side of the demand equation is the lack of meaningful energy alternatives: "You can't build a [hydroelectric] dam anymore in the US because of environmental concerns," he says. "Americans don't like coal. It is considered a dirty fuel. And green sources such as solar power are not yet well established in the commercial marketplace."

The upshot: Oil and natural gas will stay in the driver's lane for the foreseeable future, he reckons.

Still, Segner hedges his stock picks by purchasing shares in a few alternative-energy firms and could move into more if the subsector becomes ripe.

Currently, his fund holds about 40 companies out of a pool of about 300 energy firms that he tracks. Oil-service firms make up 35 percent of his portfolio, followed by exploration firms linked to natural gas (22 percent), and international oil companies (21 percent). Companies in his portfolio include Coastal Corp. (about to merge with El Paso Energy to create the largest natural-gas company in the US), Nabors Industries, Noble Drilling, Philips Petroleum, and Devon Energy.

Most of Segner's firms are in the mid-cap (medium-sized) range. He is reluctant to invest in small companies because then he would need a much larger portfolio than the 40-to 50-company portfolio he favors.

While much attention has been focused on potential oil and gas shortages through the winter months of 2000 and early 2001, Segner believes that prices may drop a tad by next spring. But the supply problem will continue for the next few years, he says, in part because there is no comprehensive federal energy policy.

The wild card in assessing energy supplies, he says, is Iraq. If Iraq slashes production, that could put more upward pressure on prices. If it increases production - to gain much-needed foreign currency - then prices might drop, Segner says. Last week's agreement between Iraq and the UN makes oil interruptions unlikely for now.

If you want to buy into an energy fund, "you should do so by the end of this year," he says, since the "best gate" for energy-related stock returns will be from now through the year 2001. Still, he predicts energy funds will do well for the next several years, although their rates of return will gradually moderate.

Having a small stake of about 5 percent of one's total portfolio in this volatile sector can make sense for investors, says one analyst from Morningstar - and provide a much-needed kick to returns.

(c) Copyright 2000. The Christian Science Publishing Society