Energy Stocks: Best Way to Invest to Profit from 2010 BP Gulf of Mexico Oil Spill

Sam Subramanian PhD, MBA

The energy industry is very much in the news after Deepwater Horizon, a drilling unit owned by Transocean (RIG) exploded on April 20, 2010. Damage from the resulting oil spill, the largest in U.S. offshore drilling, could exceed $50 billion. The U. S. Government has named BP (BP) as the responsible party in the incident. Shares of both BP and Transocean are down roughly 50% each since the incident.

This incident is the last thing energy stocks need with crude oil prices already under pressure from concerns of weak demand and a stronger dollar. Shares in the energy sector are among the worst performers this year. The Energy Select Sector SPDR ETF (XLE), that is made up of a basket of energy companies in the S&P 500 ($SPX), is down 13.0%.

Shares of ExxonMobil (XOM) and Chevron (CVX) yield 3.1% and 4.3%, respectively while those of Noble Energy (NE) and Diamond Offshore (DO) trade at forward P/E multiples of 6.8 and 8.2, respectively.

With energy stocks trading at historically low valuation metrics, is it time to jump in? What about BP and Transocean as deeply discounted value plays? Or, are there better ways to invest to make money from the 2010 BP Gulf of Mexico oil spill?

Moratorium on U. S. deepwater drilling imposed in response to BP's 2010 oil spill in the Gulf of Mexico has pressured energy stocks. But, the best way to profit from the oil spill lies far from the oil patch.

To understand the implications of the oil spill and pick the best investing plays, it is worthwhile to segment the energy sector into different industry groups since the implications of the oil spill are different for different groups.

Integrated Oil Companies

Operating costs for integrated oil companies will likely increase as insurance costs ramp up, regulations tighten, and permitting pace slows. These negatives to a degree will be offset by higher commodity prices resulting from lessening competition. ExxonMobil has upped the ante on natural gas with its purchase of XTO Energy and is well-positioned to benefit from an upswing in this commodity's price.

Oil spill implication:

Mildly negative

Best energy stocks:

ExxonMobil, Chevron, Total (TOT)

Oil & Gas Exploration & Production Companies

As safer ways of producing energy gain emphasis, natural gas can get a leg up. Companies with large, proven onshore resources as well as unconventional oil plays can benefit while those scouting offshore are at a disadvantage.

Oil spill implication:

Short-term positive for onshore and natural gas producers

Best natural gas stocks and ETFs:

Forest Oil (FST), Newfield Exploration (NFX), iPath DJ-UBS Natural Gas ETN (GAZ), Fidelity Select Natural Gas (FSNGX), First Trust ISE-Revere Natural Gas (FCG)

Energy Services Companies

While the moratorium on offshore drilling is an obvious short-term negative, regulatory changes are likely to provide more business opportunities for oilfield services companies by requiring robust casing architectures and frequent testing. Onshore drillers are better positioned than offshore and deepwater drillers. The oversupply in deepwater drilling is likely to worsen.

Oil spill implication:

Long-term positive for oilfield service providers and land drillers

Best energy service stocks:

Schlumberger (SLB), Nabors Industries (NBR)

Best Way to Invest to Profit from 2010 BP Gulf of Mexico Oil Spill

The near-term fundamentals for the energy sector as a whole are not particularly appealing. Factors that largely account for the underperformance of energy shares this year --- concerns of demand destruction in Europe and a strengthening U. S. dollar --- are likely to persist for sometime. It appears prudent to underweight energy stocks.

As for BP and Transocean, the political, legal, and regulatory risks surrounding these companies are essentially unquantifiable. While such shares may provide appealing long-term opportunities at some point, the bottom in these shares could be much lower than where they are currently trading. BP and Transocean shares are suitable only for venturesome, nimble traders.

A better way to profit from the oil spill dynamics lies in the insurance group. Demand for catastrophe insurance from oil and gas producers should increase as tendency to self-insure wanes. Insurers and re-insurers stand to benefit from both higher demand and higher rates. Fidelity Select Insurance (FSPCX), SPDR KBW Insurance ETF (KIE), iShares DJ US Insurance ETF (IAK), and PowerShares Dynamic Insurance ETF (PIC) provide opportunities to profit from the improving prospects of the insurance industry.

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