We’re in the heart of earnings season for the energy patch. I’ll have more to say about all these reports in next week’s issue, but for now I want to offer a few notes about various stocks and trends that are emerging. And as the proverbial squeaky wheel always gets the grease, I’ll concentrate today’s notes on the weaker names in the model portfolios.

For the most part, Energy Strategist recommendations are performing well amid the selloff in the broader markets, although there are a few pockets of weakness, coal and uranium being the two most obvious. This highlights the need to manage positions carefully and is why I occasionally recommend taking some partial profits off the table in strong stocks or hedging using a few puts. This was precisely the topic of last week’s Flash Alert, Schlumberger and Hedges.

Integrated Oils

The fact that ExxonMobil (NYSE: XOM) didn’t meet its production targets is definitely not a bearish point for the stock. This is just further proof that boosting production is becoming increasingly difficult globally.

This is why non-OPEC oil production numbers have consistently disappointed for the past few years. It seems that every year there are predictions that new oil reserves in non-OPEC countries will come on-stream and push up non-OPEC production numbers.

Such was the assumption for 2007–some projected the biggest jump in non-OPEC production in a decade. But declines from existing fields, delays to complex, multi-billion dollar developments and shortages of rigs and equipment have conspired to bring down those production estimates consistently. Exxon’s production miss is just further proof of this.

Hard-to-produce oil and lower production are bullish for oil prices, bullish for integrated oils and very bullish for internationally levered services names. My favorites in these categories are, in no particular order: Chevron (NYSE: CVX), ExxonMobil, Schlumberger (NYSE: SLB), Weatherford (NYSE: WFT), Pride International (NYSE: PDE), Seadrill (OTC: SDRLF) and FMC Technologies (NYSE: FTI). See the portfolio tables for my latest advice on each.

Coal

Coal stocks have seen unprecedented selling pressure over the past two weeks and haven’t reacted well to their earnings releases.

The eastern-focused miners that I recommend avoiding like the plague have seen the brunt of the weakness, although it has certainly impacted the higher-quality names such as Peabody Energy (NYSE: BTU) as well. In fact, Peabody touched my recommended stop-loss order yesterday, handing investors a tiny profit. Nevertheless, this didn’t feel like much of a profit given the fact that the stock was trading 30 percent higher a little over a month ago.

The bear case for the coal mining stocks is simple and, in fact, very similar to the bearish case for natural gas. Due to the hangover from the warm winter of 2005-06, stockpiles of coal at utilities have risen to excessive levels. This is the same basic reason that natural gas storage levels are so much higher than normal right now. Since the utilities are well supplied, demand for coal has fallen and so have prices.

Adding to that are concerns over climate change policy. Coal is public enemy No. 1 when it comes to global warming, and a few plants that had been slated for construction have been delayed or canceled due to uncertainty surrounding the future of US environmental regulations governing carbon emissions.

These two points were discussed ad nauseam on every one of the five coal miner conference calls that I’ve listened to so far. The Q&A sessions have become an endless debate over these factors.

As I’ve stated before, these are valid points. However, the weakness in coal is massively overdone. The fact is that the US needs more generation capacity soon, and as I’ve outlined on numerous occasions, alternative energy and conservation efforts just won’t meet those needs. Nuclear plants take a long time to build so they’re also not a great candidate for meeting near-term (two to three years out) needs. Coal and gas are the only realistic solutions, and coal is far and away the cheaper alternative even with natural gas prices at depressed levels.

Outside this broader argument, a few additional points surrounding shorter term production trends are worth noting.

New regulations being imposed on East Coast miners are starting to have a dramatic impact on coal production from the region. The Mine Safety and Health Administration (MSHA), part of the US Dept of Labor, recently drastically changed the regulations governing how mines are sealed. Basically, in underground mines, abandoned sections of mines are sealed off from the rest of the mine. This is to prevent any dangerous gasses from moving from these sections to areas that are being mined.

Over the past year and a half, MSHA has changed regulations governing the way mines are sealed on a few occasions. The end result is that about 372 of the 670 active underground mines in the US will need to make changes. MSHA estimates that this will cost the industry some $40 million annually to comply. According to the management team over at International Coal Group (NYSE: ICO)–a stock I recommend avoiding–some mines in the east have more than 100 seals in them.

No one really knows how much the new seals will cost because very few have been placed yet but it’ll be upwards of $15,000, and they’ll take days to put in place. This regulation is causing some higher-cost mines to shut down because they can’t afford to comply. Better-capitalized miners are meeting the new regs, but they’re forced to halt production for days.

In addition to that, a decision regarding the way dirt and debris from eastern mines is disposed of has made it far harder to get permitting for new mines. So far this year, no new eastern surface mines have been permitted in the US, compared to 15 by this time last year. This is also having an effect.

Finally, the scheduled expiration of a synfuel credit at the end of this year will render yet more mines uneconomic; I’ll explain this in the upcoming issue at more depth.

The consensus I’m hearing from the conference calls is that coal production is already falling from the east. This trend will accelerate after the end of 2007 because some mines are now selling coal under contracts that expire at the end of the year. Those contracts, signed some time ago, provide for decent, above-market prices. Once they expire, unless coal prices improve those mines will shutter.

Bottom line: Coal production is coming down and will soon come down fast. This will bring those inventories into line over the next few quarters. In my view, the market is overreacting to the short-term bloated inventory picture.

A year from now, I firmly believe we’ll look back on the current period as a great time to be accumulating coal stocks. My favorites are Peabody and CONSOL Energy (NYSE: CNX) for the reasons I outlined in the May 2, 2007 issue of TES, King Coal.

If you were stopped out of Peabody, stand aside for now and wait for the stock to stabilize. I’m looking for a good opportunity to recommend jumping back into this stock and will send out further updates on this stock in the near future.

Also, I recommend buying into weakness on coal-focused MLPs Natural Resource Partners (NYSE: NRP) and Penn Virginia Resources (NYSE: PVR). These high-yielding plays are on solid ground and, for reasons I’ll elaborate on next week, actually see some benefits from slightly weaker coal prices. This gives them an opportunity to buy up coal reserves more cheaply than they could a year or so ago.

The Drillers

The big news in the contract drilling space isn’t related to earnings at all; rather, it was the merger deal between Transocean (NYSE: RIG) and Global SantaFe (NYSE: GSF) announced on Monday. This has helped to push TES recommendations Seadrill and Pride higher.

Seadrill is focused on deepwater drilling rigs, one of the hottest energy-related markets right now, and remains a buy recommendation. For those subscribers unfamiliar with this story, check out the January 3, 2007 issue of TES, The Deep End.

I see this merger as a bullish development for two reasons. First, it’s likely a sign of things to come. I won’t be at all surprised to see further consolidation in this business. Again, I will get into more specifics in next week’s issue but I see Seadrill as a likely acquirer and Pride as an extraordinarily likely target for an acquisition due to its cheap valuation. For a more detailed rundown on my rationale for recommending Pride, check out the April 18, 2007 issue, More Bullish Signs.

Second, these firms are responding to what has been an ongoing criticism from analysts quarter after quarter. Specifically, Transocean and Global SantaFe are facing a strong market for their rigs and unprecedented visibility into the future. That’s because many of their rigs are locked into long-term contracts with big oil companies at ultra-high day-rates. Yet, despite these assured cash flows, these firms just aren’t taking on much in the way of debt–most would prefer they lever up and either pay a special dividend or aggressively up their share buybacks.

The Transocean/Global SantaFe deal does just that. The companies are taking on more debt as part of this deal. That debt isn’t much of a problem because the cash flows are assured under long-term contracts. When the deal is completed, shareholders in both firms will also be getting a cash payment, roughly like a special dividend.

Natural Gas/ Oil Services

I highlighted these industries and my outlook for earnings in the July 5, 2007 issue of TES, A Quarter in Review. I also discussed some of the same trends in last week’s Flash Alert. My basic outlook for these sectors was correct.

What’s striking to me is just how shockingly terrible the Canadian drilling market is right now. Every oil services conference call I have listened to has highlighted this point. The US is actually holding up rather well, though I suspect that could change if gas prices don’t start to recover by this fall or if we don’t get a few hurricanes over the next two months. Overall, however, North America is terrible compared to every other market in the world.

Longer term, a decline in drilling activity is very bullish for gas prices because it means production will start to decline rapidly. It’s bad news for North America-levered services names like BJ Services (NYSE: BJS). Continue to avoid them.

In the midst of all of this, I was a little surprised to see Halliburton’s (NYSE: HAL) numbers come in so strong. Halliburton has a huge amount of exposure to North America, particularly to the pressure pumping market. Pressure pumping is the weakest part of the services market. But Halliburton just didn’t see the deterioration in profitability and growth that some of its competitors did.

My initial reaction is that perhaps Halliburton’s greater technical expertise in pressure pumping services may be insulating it from the worst of the decline. Meanwhile, the company’s competitors competing in simpler commodity-type services are locked in bitter, vicious price war.

This assumption would seem to be backed up by a blow-out report from TES recommendation Carbo Ceramics (NYSE: CRR); the stock is up more than 7 percent in a terrible day for the broader market. Carbo makes ceramic proppants, which tend to be used in wells demanding more technically complex fracturing treatments. Keep buying Carbo Ceramics.

Agriculture/Alternatives

I’m still working through reports from companies such as TES recommendations Bunge (NYSE: BG) and Sunpower (NSDQ: SPWR). It’s worth noting, however, that these stocks are performing extraordinarily well in a down market. Earnings reports in agriculture and alternative energy are red-hot and both groups seem to be acting as safe havens for investors.