Stephen’s Posterous

In his letter last week to Berkshire Hathaway (BRKA) shareholders, Warren Buffett took himself to task for more than quadrupling the firm's stake in energy giant ConocoPhillips (COP) last year.

"The terrible timing of my purchase has cost Berkshire several billion dollars," Buffett wrote. Buffett may have got the timing wrong, but it might be wise to take his advice also contained in the annual letter: "Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."

Right now, shares of ConocoPhillips, hovering near their five-year low, are an attractive way to play an eventual rebound in crude-oil and natural-gas prices. The company's above-average exposure to natural gas compared to its peers could drive returns in an economic recovery that would also boost the lagging commodity.

The stock is trading at a sharp discount based on several valuation metrics. Shares are valued at 0.6 times book value whereas Exxon Mobil (XOM) and Chevron (CVX) are trading at 2.6 and 1.4 times, respectively.

The dividend, yielding 5%, offers stable returns in this volatile market. Lee Delaporte, director of research at Dreman Value Management, says ConocoPhillips is his firm's largest holding for a very simple reason: It is a large, diversified energy company that is also "one of the cheapest in the energy space."

"I think from a long-term perspective that I'm going to get a better return over time in a ConocoPhillips" as the valuation gap narrows, Delaporte says.

"ConocoPhillips shares outperformed the major integrated companies every single year from 2003 through 2007 and by a wide margin, not by one or two points," says Fadel Gheit, managing director at Oppenheimer. That stellar track record came to an abrupt end in 2008: ConocoPhillips fell 41%, versus the major integrated group's 30% decline and the Standard & Poor's 500 index's 39% drop during the year.

Gheit, who also was optimistic about ConocoPhillips and other integrated oil companies early last year, admits, "Warren Buffet and I made a mistake. I never thought that [oil and natural-gas] prices would collapse the way that they did and stay the way they did, but obviously you live and learn."

A rebound in oil to at least $55 a barrel and natural gas to $6 per million British thermal unit "will make this stock very cheap," Gheit says. The market is valuing ConocoPhillips' oil reserves at $9.46 a barrel versus the group average of $11.11.

ConocoPhillips stock typically trades at a discount to its peers. That's because the company has a history of making untimely acquisitions at the top of the market. In the fourth quarter, the company took a whopping $34 billion write-down largely for its acquisition of Burlington Resources in 2005 and a 20% stake in Russian oil giant Lukoil in 2007.

This is a noncash accounting charge, but "the slate's been cleaned and when gas prices recover, it's going to be positive for them," says Dreman's Delaporte. Even so, the company built its way into the group of major integrated oil companies and commands an impressive reserve base with attractive long-term growth opportunities, such as developing liquefied natural-gas facilities in the Middle East.

ConocoPhillips has cut spending and halted its stock repurchases so that it can essentially live off of cash flow. The company ended 2008 with $755 million in cash compared to $35 billion at Exxon and $24 billion at Chevron.

As the "junior member of the elite club," Gheit notes that ConocoPhillips is more susceptible to shocks -- such as Venezuela's move to nationalize reserves in 2007. Its large exposure to volatile natural gas (40% of production) has been a drag in the downturn, but the upside potential from here is significant.

Oil and natural-gas futures fell 70% from last July's peak to trough a few months later, but the 9% rebound in natural-gas prices has lagged the 33% recovery in oil, says Gheit. "I think oil prices will go higher and gas will be catching up." This would also improve margins. ConocoPhillips' profits fell to $8 a barrel of oil equivalent in the fourth quarter from $24.40 in the third quarter, wrote Barclays Capital analyst Paul Cheng in a Jan. 29 report.

Earnings are expected to drop from $10.66 in 2008 to $4.03 in 2009 before climbing to $6.03 in 2010, according to Thomson Reuters.

Margins for producing gasoline and other oil products have improved as refiners slashed production to match demand. So this refining component "will be helpful in this particular period rather than be hurtful," says Carlton Neel, portfolio manager at Virtus Investment Partners/Zweig Advisers. Refining and marketing operations make up about 20%-25% of revenues.

The company is holding an analyst meeting on March 11. At its current price, we suspect that Warren Buffett's excitement for the stock could be rekindled.

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Berkshire Hathaway shares lost more than 30% in 2008, and more since. Meanwhile the value of the company's portfolio fell just 10%. The Sage of Omaha doesn't focus on the share price. But he says risks, formerly under appreciated in the investment world, are now being overpriced. As that corrects, shares of the billionaire's investment company could benefit.

Buffett admits he "did some dumb things", most notably buying billions of dollars of ConocoPhillips stock when energy prices were near their peaks.

Even so, the per share book value, or assets minus liabilities, of Berkshire's holdings fell a smidgeon less than 10% in 2008, against a 37% loss on the S&P 500 index and a near 20% fall for the average hedge fund. In that context, the Nebraskan investor's worst performance since 1965 - and only his second annual decline in book value - doesn't look so bad.

Berkshire shares tell a different story. At the end of 2007, they traded at a premium to book value of more than 80%. By the end of last year, the premium had shrunk to less than 40%. Now, it's only just more than 10% based on the year-end book value, admittedly now too high. The shares are off almost 50% from their late 2007 peak.

Of course, the gloominess of the economic outlook is a real concern. Buffett sees the economy in a shambles through 2009 and probably beyond. That affects both Berkshire's own businesses and those of companies whose stock it owns. But other potential worries look less rational.

One centres on derivatives. Berkshire has written put options on global stock indexes and various derivatives on corporate credit. These have generated $13bn-odd of paper losses between them, so far. Yet not only is Buffett's record comforting as to the eventual outcomes, the exposure is scaled to Berkshire's capacity - unlike, say, that of the flailing American International Group. An improbable total loss on the credit derivatives, for instance, would absorb only half Berkshire's cash on hand.

Meanwhile, Buffett's company has one of the strongest balance sheets in the US, which he calls it Gibraltar-like. As shown by his investments in the stock or debt of companies as diverse as Goldman Sachs, Harley Davidson, General Electric, Swiss Re and Tiffany, he is finding opportunity amid the carnage.

A fearful market could be focusing too much on the unhappy keywords attached to Berkshire: finance, derivatives, investments and insurance, to name a few. When irrational fears start to subside, the Buffett premium could return. While it might be damped by the fact that the 78-year old isn't mortal, that could still help Berkshire stock even before the underlying investments turn around.

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It's been a challenging year at Berkshire Hathaway. While Chief Executive Warren Buffett has made a slew of savvy preferred stock and corporate-bond investments, the company's famed portfolio of stocks has been slammed in the ongoing bear market.

So far this year, Berkshire's class A shares have slumped 20% to $77,500, near the lowest level in five years and just over half the stock's peak reached in late 2007.

The investment company's woes come in spite of recent investments outside the common stock market. For example, the company has bought $2.6 billion of convertible securities from Swiss Re that pay a 12% interest rate. Berkshire also has bought a series of bond issues from the likes of Vulcan Materials, Harley Davidson, Tiffany and Sealed Air that pay 10% or more.

Berkshire's problems these days clearly stem from its equity portfolio, which could be down more than 25% in 2009, based on our calculation of the performance through yesterday of Berkshire's 17 largest investments, which historically have accounted for over 85% of the portfolio.

Wells Fargo has been the biggest disaster, as Berkshire's holding of 290 million shares as of Dec. 31, 2009, has lost more than half its value as Wells Fargo dropped to $12 from $29 on Dec. 31. That alone has cost Berkshire over $5 billion. Other losers include American Express, U.S. Bancorp, Procter & Gamble and ConocoPhillips.

Coca-Cola, Berkshire's largest holding at $8.5 billion, has held up relatively well, declining about 5% year-to-date, versus a drop of 17% in the Standard & Poor's 500 index. The total stock portfolio now may have dropped below $45 billion, down from $76 billion on Sept. 30.

Wall Street is eagerly awaiting Berkshire's fourth-quarter earnings release, which is expected late Friday, February 27, 2009, and the company's annual report on Saturday, February 28, 2009. The annual will contain Buffett's widely read shareholder letter, as well as more detailed disclosure on the $37 billion of long-dated equity puts on U.S. and major foreign stock markets that Berkshire had sold as of Sept. 30.

The rising value of those puts and the resulting losses on that derivative position have weighed on Berkshire shares partly because it's not easy to gauge the value of the puts, which have an average maturity of 13 years and can only be exercised at maturity.

The customized puts, which aren't traded on any exchange, had suffered a loss of $1.7 billion in the first nine months of 2008. Additional losses since then could top $5 billion. Berkshire also has suffered unspecified losses on some $10 billion of credit derivatives linked to junk bonds given that market's fall since Sept. 30.

Investors typically value Berkshire based on book value and earnings. Based on both measures, the stock looks attractive. We estimate that Berkshire's current book value is in a range of $62,000 to $65,000 a share, down from more than $77,000 on Sept. 30 and roughly $71,500 on Oct. 31.

This suggests that Berkshire now trades for about 1.2 times book value, below its average of 1.5 times book in the past decade. Berkshire's market value now is $118 billion. Based on third-quarter results, Berkshire's operating profits are running at an after-tax annual rate of about $5,300 per share. This means Berkshire trades for a relatively reasonable 14 times estimated '09 earnings.

Berkshire's results this year likely will be depressed by the economy since some of the company's wholly owned businesses are involved in retailing, building materials and manufacturing. Berkshire, however, will be helped by its new high-yielding investments, including the total of $8 billion of 10% preferred stock that it purchased from Goldman Sachs and General Electric in the fall.

Investors will be going through the '08 annual Saturday and focusing on year-end book value, which may have stood around $70,000 a share; the equity derivatives loss in the fourth quarter and guidance about how to value those puts, as well as Berkshire's cash position.

The company had nearly $28 billion of cash at its insurance units on Sept. 30, but that position fell in October as Berkshire bought $5 billion of Goldman preferred, $3 billion of GE preferred and $6.5 billion of Wrigley debt and preferred stemming from its buyout by Mars. Cash may have dropped to the $10 billion to $15 billion range at year end.

The declining cash position may have been a reason that Berkshire sold over half its equity holding in Johnson & Johnson in the fourth quarter, raising almost $2 billion. Berkshire is on the hook to purchase $3 billion of convertible preferred stock of Dow Chemical if it goes through with its deal to buy Rohm & Haas.

Berkshire has taken some lumps this year, but it remains a financial powerhouse at a time when credit is dear and investment opportunities are plentiful. This plays to Buffett's strength, although he probably wishes he had invested less in 2008 and had more cash to invest now.

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For most oil producerss operating in an environment of low crude prices and low demand, discretion is the better part of valor. But Cnooc (ticker: CEO) surprised the market Jan. 20, 2009, by saying it would raise spending by 19% to $6.76 billion this year, in contrast to peers like ConocoPhillips (COP) and Chevron (CVX), which have been sharply trimming budgets or holding them flat with 2008 levels.

Cnooc's plan, accompanied by aggressive 16% to 18% production-growth targets for 2009, would let China's top offshore producer, by capacity, strike it rich, if oil prices rebound substantially from lows in the $30s anytime soon. It is a big if. Goldman Sachs says it expects benchmark West Texas Intermediate crude to average $45 a barrel this year, while Deutsche Bank sees it averaging $43 in 2009 before rising to $55 in 2010.

Contagion from weakening demand in the U.S. and Europe is reaching Asia, where export-oriented factories in China are closing, as orders thin out and energy-intensive industries such as steel and cement scale back output. The International Energy Agency said this month that it expected 2009 global crude demand to contract 1.1% from 2008. This would be its biggest annual fall in 27 years.

A glance at Cnooc's financials reveals little cause for concern. The rally by crude to record highs above $145 a barrel last July helped Cnooc amass a sizable cash hoard of 44 billion yuan ($6.4 billion), estimates Tokyo-based Daiwa Institute of Research. As a pure exploration-and-production play, Cnooc hasn't been exposed to the refining losses that depressed earnings of domestic rivals PetroChina (PTR) and China Petroleum & Chemical (SNP), known as Sinopec.

However, Beijing-based Bradley Way, BNP Paribas' head of Asian energy research, says Cnooc's plan quickly will whittle down this cash pile, noting that the company's 19% year-over-year increase in capital spending in 2009 comes atop about a 40% rise in '08. Way views a $52-a-barrel average oil price in 2009 as a key threshold. Lower than that, Cnooc will have spent in just one year all the cash it built up during a six-year bull market for crude.

"Other oil companies are tightening their belts, and holding on to their war chests for acquisition opportunities," says Way, who rates Cnooc a Hold with a target price of HK$7 (about 90 cents). Cnooc's shares in Hong Kong fell 2.6% on the first day of trading after the capital-spending program was unveiled, reflecting concern among some investors that the company will burn up vast sums to bring projects on-stream when returns are low, due to the subdued oil price.

The stock is down 48% since the start of July, compared with a 41% decline in the broader Hang Seng Index. "If the WTI oil price were to average $60 a barrel or below, we might see a negative free cash flow for [Cnooc in] 2009," says Daiwa analyst Andrew Chan.

Although Cnooc's cash pile was large enough to cover the burden of higher capital expenditure in 2009, Chan says "we think persistent negative free cash flow may reduce potential merger-and-acquisition opportunities, unless Cnooc raises more cash through debt or equity financing." He forecasts Cnooc to post a net profit of CNY30.92 billion yuan in 2009, down 31% from an estimated CNY44.75 billion for 2008. He rates it Underperform.

Cnooc has teamed with state-owned China Petrochemical in two acquisition deals that are close to being finalized, people familiar with them say. Cnooc and Sinopec are working toward a deal valued at not more than $400 million for Talisman Energy 's (TLM) natural-gas assets in Trinidad and Tobago, and have also jointly offered $1.8 billion for a 20% stake in a deepwater Angolan oil block put up for sale by Marathon Oil (MRO).

But not everyone thinks that Cnooc's plan to spend big going into a recession is all that risky. Costs in the oil industry, such as steel, are coming down. Although rig rates have so far held up, industry analysts predict the highest day rates on new contracts will fall by about 15%.

Moreover, spending heavily on new projects now could make Cnooc a winner when oil prices pick up, as many of its rivals have either chosen not to expand operations significantly or have been unable to do so because of the credit crunch. ConocoPhillips plans to cut 2009 spending to $12.5 billion, 18.3% below last year's level. Chevron's $22.8 billion capital-spending program for 2009 is unchanged from 2008.

According to DBS Vickers bank in Singapore, Cnooc's aggressive capital-expenditure plan will support production growth at double-digit levels for the next few years. It rates the stock a Hold, with a price target of HK$7.77.

Many analysts say Cnooc no longer deserves a premium as a growth stock, given that its biggest projects in Nigeria, Indonesia and China's Bohai Bay are all due online by the end of 2010 at the latest, so investing heavily now could be a catalyst for the shares when the crude market recovers.

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Missing among the dozens of articles about how ExxonMobil on Friday broke its own record of being the most profitable company on the planet was any mention of the billions it could have made but did not.

It was easy for an energy executive to look like a genius during the bull market in oil and gas prices that peaked last summer. Nearly every project was a winner, but Exxon’s executives applied a far higher hurdle rate, choosing to generate free cash flow as others invested. Some shareholders chided them for their conservatism. Added to this was sniping from environmentalists for failing to embrace green technologies to the same extent as some of its peers and by irate motorists for simply making so much money. Love them or hate them, Exxon’s bosses navigated the energy boom superbly and are now well positioned to make the most out of the bust.

Last year they returned $40.1 billion to shareholders through buybacks and dividends or 154 per cent of their capital investment and exploration spending. This is in sharp contrast to fellow supermajors. Royal Dutch Shell returned just 37 per cent of expenditures to shareholders. BP and Chevron were at 61 and 67 per cent, respectively, while ConocoPhillips was the next most prudent at 87 per cent.

Meanwhile, the credit crunch has left some mid-tier oil companies poorly prepared to develop promising fields as internally generated cash flows slump. North American oil and gas companies now sport valuations that assume oil prices of $52.50 a barrel in perpetuity, according to Tudor Pickering & Holt.

By contrast, equilibrium prices may be closer to $80, says the International Energy Agency. With big projects still elusive, these valuations have spurred talk of Exxon expanding reserves through acquisitions rather than the drill-bit. Like a value investor, it was fearful when others were greedy and now has the cash to be greedy when others are fearful.

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In a challenging 2008 for stocks, big oil shares have provided some respite rising through midyear before losing ground as petroleum prices slid from the astounding peak around $147 a barrel that they hit in July.

With crude more than $100 below that level, shares of the integrated oil giants, companies that do everything from exploring to producing to refining and distributing, remain in a slump. These stocks look tempting for long-term investors, but there's no need to rush. Big oil stocks could get even more tempting in coming weeks as the companies report earnings, issue subdued guidance for 2009 results and reduce the value of their reserves to reflect the latest realities of crude pricing.

The U.S. Energy Information Administration expects oil to average about $43 a barrel in 2009, while some Wall Street energy bulls consider $60 more likely. If either forecast is right, oil stocks will benefit later this year. If on the other hand, crude slides below its current level, as some Street bears expect, the shares could stumble further.

A recovery will eventually come, and higher oil prices surely will follow. The most enthusiastic bulls even see them returning to $100 within a few years. Patient investors would do well to buy the stocks of the best-positioned companies with the strongest finances and best long-term outlooks and this includes: ExxonMobil, Total and BP. Also worth considering, although more speculative: Petrobras.

Of the top three, ExxonMobil (XOM) looks the most expensive, but its strong cash position makes it the No. 1 candidate for a dividend increase. The company, the world's largest non-government-owned energy outfit, is also a low-cost petroleum producer, as are France's Total (TOT) and the U.K.'s BP (BP), each of which also has impressive natural-gas holdings. Brazil's Petroleo Brasileiro, known as Petrobras (PBR), a smaller, production-heavy player, has made some intriguing energy discoveries, but some can't be exploited profitably at current petroleum prices.

The story is not as positive for the other big players, whose shares are cheaper for good reasons. Although it has a decent cash position and dividend, Royal Dutch Shell (RDSA) trades at a discount to its peers, in part because of its miserable history of writing down the size of its reserves. ConocoPhillips (COP) has a weaker balance sheet than most of its rivals, leaving it at a disadvantage in bidding for assets to replace its maturing reserves. And Chevron (CVX) looks downright expensive, especially in light of its high reserve-replacement costs.

The challenge for the publicly traded global giants is replacing their oil and natural-gas fields on a massive scale. National oil companies, chasing profits, now control about 80% of the world's oil. As energy prices rose, ExxonMobil and ConocoPhillips were among the companies booted from nationalized projects, most notably in Venezuela.

The political realities have forced the majors to do much of their exploration in difficult terrain, where finding-costs are high. The good news is that oil-rich countries seeking to fill growing budget holes are likely to offer more attractive terms to the majors, says Daniel Yergin, an energy expert and the author of The Prize, an oil-industry history. The inducements: the majors' access to capital and ability to execute projects and to marshal technology.

The major, independent energy companies still can thrive with oil prices down because they are "so big and diverse, they benefit in the chemical and refining areas from a drop in prices...," says Sean Bogda, a money manager at Global Currents, a unit of Legg Mason.

One big bull on the sector is Tim Guinness, who runs the Guinness Atkinson Global Energy Fund (GAGEX). He contends that all the integrated oil stocks are a "screaming buy" with more than 50% upside, if you believe, as he does, that petroleum prices will average $60 in 2010 and $70 in 2011. The money manager's argument: The Organization of Petroleum Exporting Countries (OPEC) wants $70 oil and ultimately will take the actions necessary to obtain it, even if its members have an interest in "giving the world an economic break" with lower prices for now.

One threat overhanging all of the oil companies is the possibility that the Democrat-controlled Congress will revive the windfall-profits tax of the 1980s. But just how deeply such a levy would bite into earnings and whether it really would be imposed are both unknowns at this point.

Bears also fear that dividends will fall unless crude and natural-gas prices heat up. But, says Jeff Parsons, an energy analyst at Eaton Vance Management: "Integrated oil companies, even if they have a downturn in cash flows, rarely cut the dividend-they try to maintain or grow it. What they can do is reduce their capital expenditures." In fact, capex budgets are shrinking already, in line with oil prices.

ExxonMobil

This company is in a league of its own, not just for its girth and $37 billion cash stash, but for its low reserve-replacement costs -- born of many accessible energy fields and superior technology -- project-financing capability and a shrewd but conservative management team. Headed by CEO Rex Tillerson, Exxon's management gets consistent praise on Wall Street.

This is why Exxon investors have long paid a premium multiple, which today stands near 14 times estimated 2009 earnings of $5.51. That's a roughly 10% premium to the integrated oil sector, but well below the 30% the stock boasted last year. Exxon shares have been the most stable among those of the big energy firms, down only 6% over the past 12 months. In contrast, its 2% yield is the lowest among the integrated giants. But, given the company's powerful financial position, bulls argue that it's likely to boost its payout, after having emphasized repurchases in recent years.

Exxon spent $26.9 billion in 2008's first nine months, shaving its total of outstanding shares by 5.5%, to roughly five billion. The company has repurchased more than 2 billion shares over the past decade. If the buybacks were to continue apace, Deutsche Bank analyst Paul Sankey has quipped, ExxonMobil could be a private company by 2020.

ExxonMobil didn't respond to a request for comment. It noted in third-quarter filings, however, that dividends rose 13% per share in 2008's first nine months -- largely the result of fewer outstanding shares. Recently, speculation has grown about whether ExxonMobil will make an acquisition. Among the rumored targets are Britain's BG Group (BG.U.K.) for its natural-gas assets. There has even been talk of a bid for all or part of Royal Dutch Shell, a deal that would face regulatory hurdles.

Total

This big French energy company's outlook is being brightened by the appeal of liquefied natural gas, especially outside the U.S. Standard & Poors expects the company's natural-gas reserves to be significantly bolstered by a recent agreement with Russia's Gazprom. Under it, Total obtained a 25% interest for 25 years in a Barents Sea gas field that the two will exploit together.

Unexpected shutdowns in Africa and the North Sea cut production last year, but European refining margins were up 88% in the third quarter alone. With low-cost production in Africa (the source of 42% of Total's earnings before interest and taxes, according to S&P), and rapid expansion in the Middle East, Total should thrive if oil prices stay at current levels or rise. The French major had $17 billion in cash at the end of the third quarter. S&P has a 12-month target of $92 on the stock, double the current price.

BP

In recent years, BP has blitzed consumers with clean-energy ads and expanded its natural-gas operations, especially in the U.S., where last fall it agreed to pay $3.7 billion for some of Chesapeake Energy's shale assets.

But oil still looms large in the company's fortunes, and its earnings are likely to be hurt in the near term by low crude prices in Russia, where a joint venture accounts for about a quarter of production. In addition, profits could be squeezed by the restructuring of BP's considerable refining operations, including its Texas City, Texas, operation, the third largest in the U.S. Chief Financial Officer Byron Grote has said that BP's $3.36-a-year dividend isn't endangered, assuming oil stays in the 40s. Investors obviously are skeptical, however; the company's shares are off about 11% this month.

Petrobras

This Brazilian energy concern's shares have fallen about 50% in the past 12 months. While considerably smaller and less diverse than some of the other integrated outfits, Petrobras has crashed the Big Oil party because of a huge discovery under salt deposits deep off the coast of Brazil. The costly project will take years to come to fruition, and some analysts contend that it might be viable only if oil fetches $60 a barrel; the company says the real figure is closer to $40.

The uncertainty over this important discovery makes Petrobras more of a gamble than ExxonMobil, Total or BP, especially since it sells at a higher valuation than any of them. In addition, the Brazilian government, which controls about a third of Petrobras shares, has encouraged the company to return more profits as dividends. Petrobras now yields 3.7% -- a number that's likely to rise slightly this year. One possible drag: higher taxes on oil profits by the Brazilian government. As for Petrobras stock, Deutsche Bank cut its target to 35 in December. But that's still well above the recent 24.29.

Royal Dutch Shell

Natural gas has become a more attractive fuel because it burns relatively cleanly and can be transported easily in liquefied form. Royal Dutch plans to double its liquefied natural-gas capacity by 2010, according to S&P. That includes a large Russian LNG project to be completed this year. Offsetting this is that, if oil prices don't rise from current levels, profits will fall at Royal Dutch's high-cost Canadian oil sands operations.

In January 2004, before Royal Dutch Petroleum and Shell were unified under one U.K. parent company (resulting in a confusing batch of tickers), Shell was forced to remove billions of barrels of "proven" reserves from its books, resulting in huge financial restatements. Criminal investigations yielded nothing, and the whole mess is history, but its legacy endures in investors' skepticism about Royal Dutch's management. That might change a bit after the company's well-regarded chief financial officer, Peter Voser, takes over as CEO this year.

Royal Dutch Shell's A shares, which underlie its most active American depositary receipts, carry the lowest multiple among the big oil stocks, even though the company has more than $8 billion in cash and offers a nearly 7% dividend yield.

ConocoPhillips

This company, whose stock could rally as its low multiple attracts investors, has the highest exposure among the super-majors to the North American natural-gas market.

It also has one of the most capital-intensive portfolios among the U.S. integrated energy outfits. Unless natural-gas prices this year exceed $7.50 per million British thermal units, well above the current $4.70 or so, the stock has only modest potential upside this year, writes JPMorgan analyst Michael LaMotte, who has a 12-month price target of $53. The shares now are in the high 40s.

Chevron

Shares of this company, which acquired Unocal in 2005, held up relatively well in 2008; they're down 14% over the past 12 months. LaMotte upgraded the stock earlier this month to Overweight, saying that with a higher percentage of crude production, compared to Exxon or ConocoPhillips, Chevron "can move more than the peer group on crude-price movements."

While it has far-flung exploration and production projects, from those on land in Saudi Arabia to deepwater Nigeria, it also is searching for oil in deep areas of the Gulf of Mexico, where hurricanes hurt production last year. LaMotte has a target price of $95 on the stock, for an upside of 36%.

Not everyone is a fan of this stock, however. After Chevron released an interim fourth-quarter report showing that refining margins were down, Credit Suisse lowered its earnings estimates, reiterated its Neutral rating and maintained its $68 price target. The shares were around 70 at midday Friday.

In sum, the long-term picture for Big Oil is generally bright. But, given the differences in the companies' strengths and prospects, investors will have to be picky to find the biggest winners. And winners there will be, because despite the hopes of environmentalists and foes of Big Oil, it will be years before conservation and alternative-energy sources can slake much of the world's thirst for petroleum.

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Options traders rushed into 2009 with a surge of activity in energy companies. With the price of oil and natural gas climbing, traders took positions in producers, drillers, and other energy companies. Trading in ConocoPhillips was especially robust, with investors picking up 32,000 calls that allow them to buy the company's stock and 15,000 puts that allow them to sell it, according to Track Data.

Traders showed interest in January 2009 calls that allow them to buy ConocoPhillips stock for $55. Priced at $2, those contracts show a profit if the stock jumps above $57 before January 16, 2009. At 4:00pm on January 2, 2009, in New York Stock Exchange trading, ConocoPhillips was up $3.05, or 5.9%, at $54.85. There was noteworthy volume in McMoRan Exploration after one trader pursued a straddle in longer-dated January 2010 contracts. The trader appears to have bought January $12.50 calls and January $12.50 puts, looking for volatility in the company's share price.

If the trader was establishing a new position, as opposed to closing out an existing one, he paid about $10 and would show a profit if McMoRan jumps above $22.50 or fall below $2.50. McMoRan shares rose 46 cents, or 4.7%, to $10.26 on January 2, 2009. The jump in oil and gas prices also sparked activity in companies that provide services to the energy sector, including Halliburton and Nabors Industries.

In Halliburton, traders liked January $20 calls. Priced at 70 cents, the contracts show a profit if the shares rise above $20.70. On January 2, the shares rose $1.27, or 7%, to $19.45. Early in the session, one large trader showed up to pursue a bullish position in Halliburton's January 2010 contracts -- buying $20 calls and selling twice as many $12.50 puts.

By selling the puts, the trader generated nearly enough premium to buy the calls, and thereby gained exposure to upside moves for little cost. "Therefore, the break-even is slightly below the [$20] strike price of the calls," said strategist Frederic Ruffy of WhatsTrading.com. The position starts to pose a risk once Halliburton shares fall below $12.50, or 36% below January 2, close. Meanwhile, in Nabors, traders appeared to be purchasing the company's stock and buying February $12.50 puts to protect against declines below that point. Nabors rose $1.30, or 11%, to $13.27 on January 2. Source.