<THE DRIP PORTFOLIO>
Oil Revisited
Changes aplenty in the oilfield

by Brian Graney (TMFPanic)

ALEXANDRIA, VA (May 13, 1999) --

Nearly six weeks have passed since we completed our study of the oil and gas industry. In that short span, just think of all the changes that have occurred -- Shakespeare in Love won the Oscar for Best Picture, Wayne Gretzky retired from hockey, another 1,572 Internet companies went public (that's a rough figure), and Jeff grew a full beard and treated himself to eight new tattoos. My, how quickly our world changes.

Things have changed in the oil patch as well. Oil futures contracts are trading at around $18 a barrel after running up as high as $19 a barrel at one point, about 13% higher than the prices seen six weeks ago. Among the companies in the sector making news, BP Amoco (NYSE: BPA) has announced a deal to add another U.S. integrated firm, Arco (NYSE: ARC), to its name. Meanwhile, Chevron (NYSE: CHV) and Texaco (NYSE: TX) are reportedly talking about the "M" word and Royal Dutch/Shell Group has sold some of its Gulf of Mexico assets to Apache (NYSE: APA). And the share price of Exxon (NYSE: XON), our favorite company in the sector, has gained 10.5% despite reporting a 40% slide in Q1 earnings.

In light of all of these changes, our views on the oil and gas industry must have dramatically changed, right?

Wrong.

Looking at the above events individually, Jeff and I can't help but fight back a collective yawn. OPEC has received gold stars lately for toeing the line on proposed production cutbacks to stem the worldwide oil supply glut, which has helped create some of the positive sentiment currently being reflected in higher oil prices. However, the cartel still has a lot to prove before it can stamp the motto "Semper Fidelis" outside of its headquarters building in Vienna. OPEC said today that it stuck to 82% of its promised cutbacks in April. That's better than the 73% compliance reported in March, but still well short of full compliance.

All of the talk about production cuts aside, it's hard to dispute the view that OPEC's relative importance on the world stage is definitely declining, a point we emphasized during our study. Its stranglehold over the world oil markets 25 years ago has been reduced to no more than a weak tug on the ear today. That fact was best illustrated by the cartel's recent inability to protect its members from the sacrificing of an estimated $82 billion in lost revenues at the altar of low oil prices last year and earlier this year.

With that in mind, one can make a pretty strong argument that the recent rise in oil prices is more correctly attributable to improving demand conditions in emerging economies in Asia and elsewhere rather than the renewed esprit de corps of OPEC oil ministers. Many factors influence oil prices day-to-day, just as many factors influence individual stock prices in the short-term. Treating OPEC as the wizard behind the curtain pulling all of the pricing levers of the world's oil markets is the wrong way for investors to think about things, in our opinion.

The continuing consolidation trend among the major integrated firms is also not entirely surprising and fits nicely into our overall thesis of a future oil and gas industry dominated by low-cost "supermajors" competing against each other and, increasingly, against the massive state-owned oil production companies of the world. Bigger may not be always better in the business world, but in the oil world it sure is a whole lot more profitable. Based on the cost-cutting and economy of scale opportunities mergers present, it's no wonder that the majors are combining faster than you can say the word "synergy."

But overall, the oil industry consolidation trend is old news, as boring and stale as the jester-shaped Christmas fruitcake still sitting in the back of the Fool HQ refrigerator. What's interesting, though, is that the jury is still out on the question of whether some of the recently proposed combinations will get the blessing of federal antitrust regulators. In fact, if there is a wicked witch that can blow the supermajors back to Kansas in a heartbeat, she's riding on a broomstick with "Sherman Antitrust Act of 1890" engraved on the side.

That menacing possibility is reflected in Mobil's share price, which continues to trade at the same 5.5% discount to Exxon's proposed buyout price that it did six weeks ago. To give the trustbusters plenty of reviewing time, the companies have pushed back the expected closing timeframe for their merger from sometime this summer to September at the earliest. Arco, on the other hand, is trading at about a 7% discount to the price BP Amoco agreed to pony up early last month, indicating doubt about that combo as well.

Those kinds of spreads may make it easier for merger arbitrageurs to get out of bed in the morning, but they do little to excite long-term investors like us. In fact, none of the recent developments in the oil sector have caused our heart rates to speed up. That doesn't mean that we are not interested in possibly investing in this sector at some point, however. We will continue to keep our eyes on things in this not-so-thrilling but ever-changing industry.

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