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Newsletter Follow-Up, Part 2

Below is an article by Vince Farrell that discusses the impact on oil stock prices if oil itself falls in price. I thought you might want to read it in light of the issues discussed in the newsletter that I mailed last week.

Even if Oil Falls, Oil Stocks Are Safe
By Vincent Farrell Jr.
6/23/2008 7:30 AM EDT

Over the course of the 150 years that oil has been drilled, the price has gone up seven years in a row, according to The New York Times. This weekend’s decision by the Saudis to modestly raise production for the rest of this year and to eventually increase production targets from 12.5 million barrels per day (BPD) to 15 BPD may or may not be enough to stem the current price rise. If oil were to be released from the Strategic Petroleum Reserve, the odds of breaking the back of the price spiral would be greater.

Barron’s ran an article this weekend that predicts that oil will pull back toward $100. Since there are signs of economic slowdown in the U.S., Western Europe, Japan and Australia — which account for 57% of global oil demand — a fall in price is inevitable. However, since China uses only two barrels of oil per person per year, and India only one barrel per person, a renewed climb in the price of oil is in the cards (the U.S. uses 25 barrels per person per year, and Japan 14 barrels.)

If the commodity were to fall in price, what is the worth of oil equities? Merrill Lynch (MER) is using an estimate of $100 a barrel for 2010. If that were the case, and making some guesstimates on the profitability of refining and chemical operations, ExxonMobil (XOM) would earn $10.60 per share and Chevron (CVX) would post an EPS of $13.70.

Using Friday’s closing price, XOM would trade for just 8 times earnings while Chevron would trade for just 7 times earnings. I have no doubt that these stocks (both of which I own) will go down if the price of crude falls fast and hard. But since they didn’t surge this year while oil rose 40% (XOM is off a touch, and CVX is up a few percent), I question how much they would decline. And those single-digit price P/E multiples make me want to stay the course.