Are oil stocks a good buy?

There is something mad about a stock market that pushes oil shares down to 1997 prices at a time when the oil price itself is well over $30 a barrel.

The market is saying: 'hold on a minute! Oil prices are set to slump when the Iraqi crisis is resolved'. However, even that is not the full picture.

For funds managers are being forced to dump blue-chips like oil shares to meet their own financial obligations and this is depressing oil stock prices at a time when they should be rising. With share prices so artificially cheap, is this the time to buy?

Ultimately it still comes down to what view you choose to take on oil prices. The simple precedent of the last Gulf War suggests that oil prices will fall sharply on the resumption of Iraqi production.

However, oil futures predict a different scenario, and here we at least have people putting their money on the table, rather than coffee-table debate. January 2004 oil trades at $27 per barrel.

Now in 2000 oil averaged $30 a barrel and $26 in 2001 and 2002. What reason do we have to believe 2003 and 2004 will see a price collapse?

Removal of the 'war premium'? Iraqi oil flooding the market? Collapsing global demand? Off the wall policies by Opec?

These are all reasonable arguments but, except for the obvious end to the 'war premium', unlikely to prove correct.

Iraq will take some time to resume its oil output - and much capacity could well be eliminated by war damage - and by then world oil demand should have picked up in any case. Opec also looks unlikely to repeat its fatal policy error of 1998 and boost output in a falling market.

Moreover, the oil producers have a huge new customer in the shape of China. By 2010 AMEInfo columnist and celebrated contrarian Dr Marc Faber forecasts an extra 20 million barrels per day of new demand from Asia, which he sees pushing oil prices to $90 per barrel by 2010.

This extra demand would come on top of what must surely be an economic upturn in the Western industrialized nations. Moreover, oil supplies from non-Opec sources are running out faster than they can be replaced, and that should put pricing power back in the hands of Opec.

The shares of oil giants such as ExxonMobil, Shell and ChevronTexaco therefore look excellent buys at current levels. Lower oil prices have already been discounted by the stock market, and the wise investor might take the view that the market is being too pessimistic about the outlook.

After a period of mergers and acquisitions the oil majors are well positioned to take full advantage of a better market for their main product, and their current share prices reflect the problems of international capital markets and not the oil markets.