Oil Stocks: Independently Ugly

Independent or integrated? That is the question. At least it's a question that oil investors have to occasionally answer and it's an important question because there is a critical difference between an integrated oil company such as Exxon Mobil (XOM) and a major independent such as Anadarko Petroleum (APC).

The difference is that an integrated oil company is integrated because it refines oil and sells gasoline in addition to exploring and producing oil. Independent exploration and production firms don't have refining or downstream operations and it is the lack of downstream operations that lead the independents to have a deeper correlation to the price of oil than integrateds have. Of course, that's a good thing when oil is going up, but these days being correlated to oil isn't a good thing at all.

The declines of even the highest quality, large-cap independents in the past month is simply staggering. Shares of Anadarko Petroleum, a company with one of the largest footprints in Africa of any Western oil major along with major shale positions in the U.S., has plunged 15% since early May. Apache (APA), a company known for its proficiency in extracting crude from properties that other oil companies have given up on, is down almost 9% over the same time.

Both Anadarko and Apache are remarkably well-run companies, but their recent declines illustrate the volatility of independent oil stocks compared to their integrated brethren. The Energy Select Sector SPDR (XLE), which devotes more than 35% of its weight to Exxon and Chevron (CVX), has outperformed both Anadarko and Apache over the past month.

In terms of valuation, Apache's forward P/E is lower than Exxon and Chevron's, so there's a case to be made for getting growth a reasonable price with Apache at current levels. While the average analyst price targets will probably come down on these names, it's not unreasonable to say Apache is a $110 stock currently trading below $82 and Anadarko is an $85 stock currently trading below $60.

The problem with waiting for those lofty prices to materialize is that independent oil companies are pretty mediocre when it comes to dividends. In fact, they're downright bad compared to their integrated rivals. Absent ConocoPhillips (COP), which just became an independent oil producer following the spin off of its refining operations and yields 5%, the independent don't offer much in the way of dividends. That leaves investors relying on capital appreciation in an environment where that's just not coming together for oil equities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.