The single story dominating the airwaves for the last 18 months has been energy.

From Exxon Mobil to Evergreen Solar, investors and institutions have invested more money in this sector than any other in recorded history, including the Internet / technology boom of the late 1990's. With crude oil prices hovering around record highs, a Presidential election a few months away, and a hurricane season just underway, the energy trade is not going away any time soon.
 
But the trick, as always, is to identify the winners from the losers, to separate the wheat from the chaff. With that mandate, let’s look at some stocks and figure out a way to put a tiger in your tank!
 
1. Integrated Oil & Gas Companies - Big Oil!
 
Although on the surface it would seem logical that the big winners of the surging crude price would be the large integrated names, careful examination shows otherwise.
 
Exxon Mobil (XOM) - Trading $79.75
The first name that comes to mind for about every investor out there, and for good reason. Expected to generate close to $788B in revenues this fiscal year, XOM is at the top of the food chain in the space. With a market cap of $421B, the company is nearly twice the size of Royal Dutch Shell (market cap of $220B), and more than twice the size of Chevron (CVX) at $175B . Unfortunately, Exxon Mobil, more than any other stock, has become a synthetic way to express a bullish view in the underlying commodity.

The problem with that is XOM does not necessarily benefit from surging crude oil prices. As a matter of fact, as the chart indicates has been anything but linked to the price of crude oil. Since October 18th, 2007, $96 has been a huge resistance level on no fewer than 4 different occasions - the latest being on May 21st when XOM topped out at $96.12.
 
At current levels, valuation are becoming compelling. But at 10.50 times trailing and 7.75 times forward earnings, Exxon is still more expensive then Chevron, trading at 9.25 times trailing and 6.5 times forward earnings and Conoco Phillips (COP), trading at 7.5 times trailing and 5.5 times forward earnings. PEG ratios (price/earnings to growth) also indicate that XOM may still be a tad expensive. XOM currently has a PEG ratio of 1.20 whereas ConocoPhillips comes in at .50.
 
Exxon Mobil just reported what was a disappointing 2nd quarter on July 31st. EPS (earnings per share) of $2.27 came in well short of the Street consensus number of $2.52. Revenues of $138.07 were astronomical, but also fell short of Wall Street expectations. The release of 2nd quarter earnings may finally have washed out any weak longs that were playing XOM as a proxy for the broader energy market.
 
From where I sit, Exxon Mobil has room down to December 2006 highs of $77. An outright short at these levels probably does not make a lot of sense - I would much rather look to be an aggressive buyer on the pullback.
 
2. Oil Services
 
Halliburton (HAL) - Trading $45.75
Baker Hughes (BHI) - Trading $84.00
Schlumberger (SLB) - Trading $100.00
For my money, these are the big three in the oil service space.
 
On May 25th, The Financial Times reported that Saudi Aramco was considering spending $129B on projects over the next 5 years. That represented an increase of $40B over previous estimates from the company. Along the same lines, back on March 5th, Exxon Mobil announced that 2008 capex (capital expenditure) spending will come in around $25B, up from $20B in 2007. If so, all of the big three win.

Schlumberger is probably best suited to lever the incredible international growth story. To that end, after reporting a very solid 2nd quarter on July 18th, Schlumberger cited improved drilling in the North Sea as well as a favorable exploration mix and better performance in projects throughout Mexico and Russia. SLB's huge international backlog also illustrates that point.
 
Schlumberger also believes in their own shares. On April 18th, SLB reported a pretty solid 1st quarter and announced they had repurchased 7M shares for $564M during the quarter, leaving 3.1M shares on the authorization. They went on to announce that a new $8B share repurchase plan was authorized with the stock to be acquired before December 2011. At 22.50 times trailing and 16.50 times forward earnings, SLB trades at a rather large premium to Baker Hughes (BHI), which trades at 17 times trailing and 13 times forward earnings, as well as Halliburton (HAL), currently trading at 17 times forward and 12.50 times trailing and forward earnings. It is also worth noting that on July 24th, BHI increased their share repurchase plan by $1B. As for Halliburton, $2B remains available on their repurchase program.
 
For my money, SLB is the class of the field and does warrant a richer valuation. That being said, the stock has struggled to trade up through $107 on a few occasions over the last month. The $97 level which has been support a number of times since mid April has been right on the precipice of breaking. If so, a quick pull back to $90 would seem inevitable.
 
Halliburton, on the other hand, has had a rather nice chart pattern making higher highs and higher lows since bottoming out around $31 in late January. Allow that trend to be your friend. A close below $45 would force me to reconsider.
 
For me, oil services will be the best way to play the energy space going forward. Recently, Wall Street analysts have seen the light. On July 16th, Morgan Stanley made positive comments in the space. Morgan went on to raise their price target on SLB to $155 from $145 as well as raising their price target on BHI to $130 from $120. Prior to that, Lehman Brothers raised their price targets on a slew of oil service names. Included among them was Baker Hughes (BHI) with an overweight rating and a price target of $110, Halliburton (HAL) with an overweight rating and a price target of $68 and Schlumberger (SLB) with an overweight rating and a price target of $142. Keep in mind, these names tend to overperform on strong tapes, but underperform on poor tapes due to the vast amount of momentum players in the stocks. Overall however, I still feel this is the best risk reward group in the energy sector.
 
For The Alternative Energy Fans Out There!
 
Evergreen Solar (ESLR) – Trading $9.10
Talk about a stock that has given and taketh away over the last year! Getting tired of rising electric bills? Thinking of putting some solar panels on your roof? Well if so, there is a good chance that the solar panels you purchase have some tie in to Evergreen Solar.  Headquartered in Marlboro, Massachusetts, and with a market cap of $1.4B, ESLR has been either a stock players dream or nightmare depending upon how you have been playing it.
 
On July 17th, ESLR reported a 2nd quarter loss of $0.08 versus Street expectations of a $0.10 loss. They went on to slightly lower their guidance for the 3rd quarter. But I’m not in the camp of those who believe ESLR is an earnings story. This stock is pure and simply a trading instrument.
 
So how does one trade it?
 
On May 22nd, ELSR announced that they signed two new long-term contracts worth in the neighborhood of $1B. The stock, which closed at $9.10 on May 21st, spiked up to $12.12 on volume of 48M shares in next-day trading. The volume represented about 5-6 times normal levels.  Can’t happen again you say? Well on June 18th after the close of trading virtually the same thing happened. That afternoon ESLR announced they signed two more new long-term contracts, valued at about $600M. On June 18th ELSR closed at $10.24, but after reading the press release, the market was ready once again to ramp the stock up the next day. June 19th, ESLR made a higher high of $12.40 on 34M shares of volume. NO WAY this can happen a third time you say? Well, let’s check out the news release on July 15th. That morning, ESLR announced they signed a new contract with IBC Solar for roughly $1.2B. Stock price action? The prior day, July 14th, ESLR closed at $9.16. The next day ESLR traded up to $10.33 on 25M shares.
 
So what is my point? Within a day or so after each of these price spikes on extraordinarily large volume, ESLR traded right back down to previous levels.

• After the May 22nd price spike – ESLR was trading back down to $9.00 by June 10th
• After the June 19th price spike – ESLR was trading back down to $8.45 by July 10th
• After the July 15th price spike – ESLR was trading back down to $8.50 by July 24th

This is a stock that we need to be looking at now at current price levels. To  wait for another press release announcing another new contract would be joining the fraternity of sheep – and as every good stock trader knows, sheep get slaughtered.
 
ESLR currently has a short interest of about 28.5M shares, or approximately 27% of the float. Each one of the price spikes we illustrated was a classic case of a short covering rally. Once again ESLR is poised to do the same.
 
Clearly, the energy space is a lot bigger than just the names we mentioned – and in future newsletter and or daily market updates, we will get into many more stocks. As a starting point, however, the companies we have discussed will provide us with a nice base.


Guy Adami
ask-guy@optionmonster.com

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