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China National Offshore Oil Corporation's (CNOOC) oil rig in China's Bohai Sea is seen in this October 21, 2003 file photo. (CHINA NEWSPHOTO)
China National Offshore Oil Corporation's (CNOOC) oil rig in China's Bohai Sea is seen in this October 21, 2003 file photo. (CHINA NEWSPHOTO)

TheStreet.com

Little-known energy picks from the pros Add to ...

Energy stocks, some of which lagged behind technology shares and other industries last year, are the best performers of 2011 on U.S. markets, rising an average of 9.4 per cent, more than twice that of the benchmark S&P 500 Index.

Almost all of the top dozen or so U.S. mutual funds ranked by returns at research firm Morningstar have an energy-industry bias and, in particular, an energy-services component. While gold and mining shares were fund-manager darlings last year, so far in 2011, the smart money is on energy as global economic growth accelerates.

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The leaders for the three months through Feb. 2 are the ProFunds Oil Equipment and Services and Distribution Fund, up 43 per cent, and a sister fund, ProFunds UltraSector Oil & Gas, up 37 per cent.

Big mutual funds of all stripes are eager to get an oil-field-services industry stake, but they usually go for the leaders, including Schlumberger and Halliburton .

Daniel Rice, manager of the $1.5-billion Black Rock Energy & Resources Fund, told Bloomberg News in an interview a month ago that he expects an expanding global economy to push oil prices above $100 (U.S.) a barrel this year and, as a result, shares of oil and gas companies may rise 25 per cent to 30 per cent while coal stocks could double.

One way for conservative investors to play the commodities market is to invest in the industries' service providers. In oil and gas , that means companies that make and supply equipment such as oil rigs, exploration services or the new technologies that makes the big-company guys' jobs easier.

Some investors are already there, as oil and gas equipment services stocks are building on last year's 37 per cent gain. But there are many interesting stocks under the surface. Here are a few:

A recent common pick among energy fund managers is National Oilwell Varco .

It is the industry leader as the oil rig and gas drilling equipment supplier, including offshore rigs, and its image hasn't been tarnished by the Gulf of Mexico's BP disaster as its competitor, Transocean, has.

The company recently issued strong fourth-quarter earnings and, more importantly, a bullish outlook for the year. Fourth-quarter profit jumped 12 per cent due to intense North American shale drilling along with a fleet of its new offshore rigs ready to enter the market. It also said it has a healthy 3 per cent backlog, or about $5-billion worth.

A Morningstar analyst recently wrote that "after years of underinvestment by drillers, the drilling industry badly needs retooled and upgraded rigs to economically drill far more complex and deeper wells. As National Oilwell Varco has spent decades consolidating the rig equipment industry, it is the best and only source of rig equipment for many of the largest offshore drillers."

Its shares are up 10 per cent this year after gaining 53 per cent last year. MFS Investment Management has a 4 per cent stake, the largest among institutional investors.

Weatherford International , one of the world's leading providers of equipment and services used for the drilling and production of oil and natural gas wells, is a top holding of the $1.8-billion Fidelity Select Energy Service. It's now its fifth-largest holding at 5 per cent. Shares of the $17-billion market-capitalization company are up 6.8 per cent this year. On the downside, it carries a relatively high trailing price-to-earnings ratio of 41.

Analysts' mean price target for Weatherford is $26.70. Those same analysts give the company's shares seven "strong buy" ratings, nine "buys," 13 "holds" and one "reduce," said S&P.

Standard & Poor's analyst Stewart Glickman said the strong growth in U.S. on-land oil drilling activity appears to have been spurred, in part, by growth in unconventional shale plays, "which fits well with (Weatherford's) capabilities, in our view."

"In 2010, North America generated 51 per cent of (its) segment-level operating income, versus just 16 per cent in 2009. Still, we think international operations present the strongest long-term growth opportunities, which we see accelerating towards the latter part of 2011," he said in a research note.

Weatherford's biggest investor is ClearBridge Advisers, at 6.6 per cent, followed by Fidelity, at 4.4 per cent. Their stakes have remained relatively constant over the past two years, according to Morningstar data

Another Fidelity energy-focused fund, Fidelity Select Energy, doubled its stake in Baker Hughes in the fourth quarter, increasing it to 2.8 per cent of the fund. Baker Hughes, a long-time industry leader with a market capitalization of $30-billion, is ubiquitous in energy funds' portfolios. It shares are up 20 per cent this year after gaining 43 per cent last year.

Standard & Poor's Glickman writes that Baker Hughes has strong growth opportunities outside North America that bode well for its future. "With oil prices remaining very resilient in 2010 in the $80 to $90 per barrel range, buoying spending confidence by upstream operators, we expect capital spending growth in 2011, which we think dovetails nicely for BHI's expansion plans," he says.

"For 2011, we see North American operating margins around 18 per cent (versus 17.6 per cent in 2010)," he wrote. "Outside North America, we see a near-doubling of margins to about 13 per cent in 2011."

Invesco Energy Services, a $1.9-billion fund that's up 8.4 per cent this year, is another big believer in Weatherford, more than doubling its stake to 4.3 per cent in the fourth quarter.

A new holding for the fund is Hess , at 2.6 per cent of the portfolio. Morningstar says Hess has amassed a promising collection of high-profile oil and gas projects to drive long-term production growth. While oil already accounts for more than 70 per cent of its production mix, Hess has the flexibility to shift to more oil-based projects to benefit from the current pricing advantage of oil over U.S. natural gas prices."

Last month, Hess said it plans to spend $5.6-billion on capital projects in 2011, including $900-million on exploration. That's up 44 per cent from plans to spend $3.9-billion in 2010.

Funds also seek opportunities in tiny, speculative stocks.

For example, the Integrity Williston Basin/Mid-North America Stock Fund, which has a restrictive agenda that calls for it to invest in stocks of companies developing the oil and potash resources from the Williston Basin area and Mid-North America area, which is roughly eastern Montana, parts of North Dakota and South Dakota and into southern Canada, is benefiting from a huge oil shale boom.

In the fourth quarter, it added Canyon Services Group , making it a 2 per cent holding of the fund late last year. The Canadian company provides specialized "fracturing" and chemical materials used to drill for oil and natural gas in Western Canada, site of a huge oil boom. Shares of the $715-million market-capitalization firm are up 3.5 per cent this year, after gaining 361 per cent last year and 209 per cent in 2009.

Another big gainer for the fund is Carbo Ceramics , which produces and supplies the unique ceramic material used by oil and natural gas drillers for the hydraulic fracturing of wells. Its shares have run up 14 per cent this year. During the fourth quarter, the fund boosted its stake by 20,000 shares to make it its second-largest holding, after National Oilwell Varco.

Its products are marketed internationally through the oil-field-service companies that provide the hydraulic fracturing services. In the third quarter, it reported a 29 per cent revenue increase, year-over-year, and a 45 per cent increase in operating profit. It has a market value of $2.7-billion.

Analysts who follow the stock give it one "buy" rating, four "outperforms," six "holds" and one "sell." The Neuberger Berman family of funds owns 13 per cent of its shares, and the next-largest shareholder is BlackRock, at 6 per cent.

Black Rock Energy & Resources recently added two very small oil exploration stocks to its roster: Far East Energy and DeeThree Exploration .

Far East Energy, with a $163-million market capitalization, is a development-stage company engaged in drilling, exploring and testing wells for future production. But it already has 38 per cent institutional ownership led by Prudential Investments, with a 10 per cent stake. BlackRock built a 9.8 per cent stake late last year. There's not much available on its financial performance but its shares have lost 14 per cent this year, after gaining 52 per cent in 2010.

Similarly, DeeThree Exploration, a petroleum and natural gas explorer based in Calgary, with a market capitalization of $147-million, has four big institutional investors, led by BlackRock's 5.8 per cent stake built up late last year. DeeThree's shares are up 15 per cent this year, after gaining 84 per cent in 2010.

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