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Funds Hit by Terrorism, Oil Scares: Market Recovers Quickly, But Long-Term Issues Remain

Events on both sides of the world brought bad news to the energy and transportation sectors this month. Although the market disruption seemed short lived, the thwarted terror plot in London and British Petroleum's pipeline problems in Alaska highlighted long-term concerns that both industries face.

News that British authorities had arrested 21 people involved in plans to hijack U.S.-bound planes from Heathrow Airport and use liquid explosives to commit "mass murder on an unimaginable scale" came in the midst of market unrest caused by BP's problems with its 22-mile pipeline across Alaska's North Slope. The clogged pipe threatened to stop 400,000 barrels worth of oil flowing daily from Prudhoe Bay.

The market stumbled, but recovery came quickly, boosted by a Tuesday rally on inflation data from the Federal Reserve.

"The fact that they managed to catch the plot changes things," said Lawrence Jones, an energy analyst with Chicago-based researcher Morningstar. "If there had been a successful attack, it would have affected volatility more," he said.

Lipper Senior Analyst Andrew Clark agreed that since the Sept. 11 attacks five years ago, investors have become more accustomed to the idea of terror, and are faster to regain confidence in the markets. "It's going to give people pause, but it's not going to stop international travel," he said.

To be sure, wild price fluctuations in energy and airlines struggling for solvency are old news to investors. But this month's events highlight subtler fundamental issues that may affect both sectors in the long term.

"This is just the worst possible timing," Clark said. Just as U.S. Air climbs out of bankruptcy, others, like Delta, teeter on the brink. Besides the fear factor affecting ticket sales, many airlines face huge pension liabilities, increased fuel costs and fare wars.

"These are not the old Ma Bell type stocks anymore," he said.

Even the sector's few glimmering stars are beginning to fade, said James McGlynn, a portfolio manager at the Summit Everest Funds in Cincinnati.

For example, budget airline Southwest had been outperforming its peers, but its specialty is the short haul, and the federal carry-on luggage restrictions make such trips more of a hassle. McGlynn noted. With the convenience factor now gone, budget airlines may suffer, McGlynn said.

Cargo carriers, however, may benefit as many business travelers are now shipping their bags via UPS and Federal Express. Although couriers also suffer from high fuel costs, they can more easily pass those costs on to customers than passenger carriers, McGlynn said.

Before they become good investments again, airlines will "have to completely change the way they are set up," he added. They might reduce the number of planes flying. "That would be good for the industry," he said.

Late in 2005, McGlynn espoused investing in railroads because they faced no competition from foreign companies and because they were a cost-efficient method of transporting cargo, compared to planes and trucks.

Today, however, McGlynn has moved out of the sector because the iron horses proved unable to keep their profit margins fat.

Clark is betting on shipping, instead, because although cargo boats need fuel, sea-fearing tankers transport oil and other natural resources, and that sector's high demand keeps vessels moving.

Demand for oil products, especially from rapidly industrializing India and China, helps keep demand strong, despite threats of a slowing domestic economy, analysts said.

This week, BP announced a partial solution that will allow the company to still deliver 200,000 barrels per day, allaying concerns over supply shortfalls.

While the news from London stalled markets, recovery came swiftly, aided further by the cease-fire between Israel and Hezbollah in Lebanon. Last week, energy funds saw better performance than they did at the start of the month, before either news in Alaska or in London broke.

"Short-term price shocks are less important than long-term fundamental changes," Clark said.

Some of the fundamentals are in place, said Bill Gerlach, portfolio manager of the Gartmore Natural Resources Fund in Conshohocken, Pa., noting Nigeria's 700,000 barrel a day production and the fact that nations in the turbulent Middle East, which rely on oil revenues, are working hard to ensure infrastructure and supply stay secure.

Nationalization of the oil industries in places such as Venezuela, Boliva and Ecuador, is concerning, but geologists assure companies that there are yet-untapped deep water reserves.

The BP scare, does, however draw attention to another issue facing the industry, which is aged infrastructure. In the Alaska case, robotic drones, known as "smart pigs," found parts of the pipeline 80% corroded. Anything over 70% threatens a company's ability to keep the black gold flowing.

Despite high prices oil, companies continue to deliver decent yields. Energy stocks still make up 10% of the S&P 500 Index. But even if geopolitical tensions relax, experts don't expect prices to plummet, since many companies face high-cost capital improvements. "It's going to be a little while before companies are able to completely refurbish and complete upgrades," Jones said.

As for exploration, Gerlach noted, "There is much more oil out there, but the question is how difficult it is to extract and how much infrastructure it will require." Another problem is a shortage of experienced engineers and technicians, McGlynn added.

Jones warned that careful portfolio selection is critical, as investing in energy is not for the meek. "Broad-based portfolios with experienced management is the way to go," he said.

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