The oil and gas industry, led by exploration and production (E&P), will be one of the stronger investments in 2003, according to Standard & Poor’s Ratings Service (S&P), which published its year-end equity market wrap-up and outlook on Wednesday. S&P expects the strengthening momentum as the year ends to carry into the coming year.

The energy sector represented 6.14% of the S&P 1500 Super Composite Index as of Dec. 13, which includes five industries: integrated oil and gas; refining, marketing and transportation; E&P; drilling; and equipment and services. “Year-to-date, the sector has outperformed the broader market, down only 10.1%, versus a 21.7% drop in the S&P 1500 Super Composite Index, on continued high oil and gas prices and expectations of improved demand as economies recover,” said energy analyst Tina Vital. “Most energy firms met third quarter earnings expectations (albeit somewhat pared back from earlier guidance in some cases), and fourth quarter earnings are expected to be slightly improved with acceleration in growth slated for 2003.”

Believing that 2003 “will be a year of recovery for U.S. markets,” S&P analysts said next year will reverse the third consecutive year of decline for its market index benchmark, the S&P 500. “Reflecting a combination of factors, including high stock valuations, sluggish corporate earning progress, and unsettling world events, investors decided to take profits in 2002 and wait for clarity with these issues before committing funds again,” said Ken Shea, managing director of Global Equity Research. “With that said, Standard & Poor’s believes that the recovery will occur in 2003.”

Strong sector momentum is expected in the energy, financial and consumer staples sectors. At the same time, S&P expects a “slowing movement” in utilities, technology and telecommunications. S&P recommended that investors overweight their portfolios in the growing energy, financial and consumer sectors because “these sectors provide investors with the best exposure to a recovery in both the economy and corporate earnings,” said Sam Stovall, S&P’s chief investment strategist. “We feel the companies in these four industries should position investors well as the market progresses through the New Year.”

Vital said that “amid an environment of higher commodity prices, the S&P Exploration and Production stock index has been the best performing industry within the energy sector so far this year.” She said “top picks” would include Apache Corp., EOG Resources and Ocean Energy, all based in Houston. These companies have “attractive valuations and above average projected production growth.” The “lone sell” recommendation was Nuevo Energy, “with a weak balance sheet, high relative valuation and below average production growth.”

The upstream spending of producers is driving revenues for drilling and equipment services companies, and going forward into 2003, “we expect international spending to remain healthy, rising near the 10% pace seen in 2002.” Vital noted that S&P estimates that North American natural gas production dropped 6% in the third quarter of 2002 over last year’s third quarter. “Even with natural gas inventories about average for this time of year, such low deliverability could cause periodic spikes in natural gas prices during the winter and lead to higher prices in 2003.” Next year, “North American producers are likely to raise drilling rates significantly,” said Vital.

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