Ride the next oil boom

By Tim Middleton

Brazil's Petrobras Brasileiro (PBR, news, msgs) in April announced one of the biggest oil discoveries in decades: an offshore field that one government official said could contain 33 billion barrels.

Two years ago, Petrobras scored another knockout with the Tupi oil field, which holds an estimated 8 billion barrels.

Don't dream of 50-cent-a-gallon gasoline, though. The newest find lies beneath more than four miles of ocean, rock, sand and salt. Drilling will be a herculean effort, and countless billions will be swallowed up along the way by oil-field-services companies, including Baker Hughes (BHI, news, msgs), which is "on the ground in deep-water Brazil," notes David Rewcastle, an analyst for Argus Research.

Meanwhile, Russian Prime Minister Vladimir Putin has vowed to boost oil production in his country as well, "and if that happens, Baker Hughes is there, too," Rewcastle adds.

Indeed, as the market wrestles with today's rising gas prices and oil-supply questions, a second oil boom has already begun. This one is all about exploration and new production, and oil-services companies will be the leaders.

Beating the market and Big Oil

In recent weeks, global stock markets have been in a wrestling match with the petroleum industry, with one side losing whenever the other blips ahead. Oil is winning overall, with the average natural-resources fund in the Morningstar database ahead 4.2% in 30-day period that ended May 27 and up 13.3% for the year.

Vanguard 500 Index (VFINX), the investable form of the S&P 500 Index ($INX), has dropped 0.7% in the past month and 4.9% this year.

But two related corners of the oil patch, drilling and oil-field services, have been doing even better than oil in general. Just look at two funds representing these sectors: Rydex Energy Services (RYVIX) is up 5.6% in the past month and 15.8% this year, while ProFunds Oil Equipment Services & Distribution Services (OEPIX) is ahead 4.9% and 15.4%.

Among exchange-traded funds, or ETFs, iShares Dow Jones US Oil Equipment and Services (IEZ, news, msgs) is ahead 4.5% in the past month and 15% this year, and SPDR S&P Oil and Gas Equipment & Services (XES, news, msgs) is up 6.3% and 17.3%.

Here's one big reason these areas look better than Big Oil long term, too:

Big Oil is hostage in one form or another to the spot price of oil. But suppliers such as the drilling and services industries enter multiyear contracts that are impervious to day-to-day whipsawing. The major oil companies "are agreeing to five- to seven-year deals for rigs that are going to take three years to build," says Standard & Poor's analyst Stewart Glickman. "That implies customers believe even waiting that long to fulfill the contract is still a good bet."

Prudent investors saw the oil crunch coming years ago, and many of us have added natural-resources funds to our portfolios to gain additional exposure to this area. But now comes the second wave, investment in new production. The companies owned by these funds -- drillers such as Noble (NE, news, msgs) and services firms like Halliburton (HAL, news, msgs) and Schlumberger (SLB, news, msgs) -- will reap the profits that flow from this investment. These funds will be carried along in their train.

The right funds

I did a search among funds for those that have concentrated the most bucks in pursuit of this bang. In addition to the four mentioned above, one name that came up again and again was Oil Services HOLDRS (OIH, news, msgs). It is a superconcentrated portfolio of just 17 stocks, with 80% of assets in its top 10 positions.

This can be a superb investment if your portfolio is big enough. HOLDRS represent direct interest in the underlying stocks and can be exchanged for them at any time. Therefore, you can buy them only in round lots of 100 shares. Last week, Oil Services HOLDRS was trading around $213.35, meaning the minimum order would be $21,335, plus commissions.

Continued: 2 key funds

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