Looking for Sparks in the Energy Group

Energy stocks were disappointing performers in 2012.

While the S&P 500 rose by more than +13% in price last year, energy stocks gained only +2%.  Only the utility sector (-3%) did worse in 2012.

The energy sector has regained some ground in 2013, modestly outperforming the market averages, but as the chart above shows, the group still has a long way to go to draw closer to the S&P.

On Monday I headed over to Barclays to hear their integrated oil analyst Paul Cheng talk about the stocks in his group.

I have long been a fan of Paul's, and several of his recommendations over the last decade that I have been following him have made significant gains for my clients.

Paul's recent thoughts can be summarized as follows:  buy the refiners, but don't expect much from the rest of the stocks he monitors until late 2014, at the earliest.

The majors (which includes Exxon, Chevron and Conoco) are all in the midst of major capital spending projects to try to improve production.  Last year the majors all reported declines in oil production, and this year does not appear to offer much hope for any improvement.  It won't be until a couple of years from now that their expenditures yield any significant results.

In Paul's view, however, the majors continue to make sense for defensive investors.  Regardless of their 2013 production levels, virtually all of the majors have huge financial resources, and their dividends can be easily maintained if not raised.  If you have to own one, Chevron would be his pick.

In a startling contrast to Paul's tepid views on the majors, he is a raging bull on the refining stocks.

Despite the fact that many refining stocks have already moved sharply higher this year, Paul thinks that companies like Valero; Marathon Petroleum; and Phillips 66 could easily double from today's levels.

Paul thinks the market is drastically underestimating the earnings leverage that the refiners will enjoy from the combination of ample oil supplies and strong demand both domestically and internationally.  The U.S. is now a net exporter of petroleum products for the first time since the 1970's, and this trend is likely to continue as American refiners can operate much more efficiently and profitably than foreign competition.

The only real risk to the refining stocks, Paul believes, is if U.S. oil production declines from current levels - a prospect that appears unlikely given the massive spending that is ongoing throughout North America.