While continued weakness in crude oil and natural gas prices are expected to weigh on the energy sector's performance over the next 6-9 months, investors with longer time-horizons will find many attractive opportunities in this battered group. In terms of commodity prices, we believe that crude oil will take its cue from the direction of the broader global economy. Natural gas, on the other hand, is a North American story and developments here over the coming months will determine its outlook.

With the heating season halfway through and visibility on the economy's front still elusive, we expect continued downward pressure on oil and natural gas prices over the coming weeks. However, with OPEC's supply cuts helping remove the current inventory overhang -- expected to start showing up in early spring -- and sentiment on the economy improving following the stimulus, crude oil prices may start consolidating in the second half of the year. If the economic picture turns out to be bleaker than expected, then a renewed move towards new lows in oil prices cannot be ruled out.

On balance though, we see more upside potential than downside risk from current levels.

OPPORTUNITIES

The indiscriminate sell-off has made the risk-reward trade-off of a number of sub-sectors very compelling, in our view. The large-cap integrateds, oilfield services and offshore drilling sub-sectors offer compelling opportunities at current levels.

The relatively low-risk energy conglomerate business structures of the large-cap integrateds, with their fortress balance sheets, ample free cash flows even in a low oil price environment, and growing dividends are well suited for uncertain times like these. Our preferred names in this group remain Exxon (XOM) and Chevron (CVX).

The underlying business fundamentals of oilfield service companies, particularly those with an international focus and deepwater-capable drilling contractors still remain robust. We like Schlumberger (SLB) and Baker Hughes (BHI) in the oilfield service space, and our preferred deepwater drillers remain Transocean (RIG) and Diamond Offshore (DO).

WEAKNESSES

We strongly feel that industry players -- particularly those in the servicing and drilling ends of the business -- having substantial natural gas-focused and North America-centric operations should be avoided.

The two major sub-sectors that fit that description would be the onshore drillers and service players with heavy pressure pumping operations. We believe that pricing and margins for operators in these two sub-sectors will remain under pressure through 2010, even as the outlook for natural gas price improves.

Halliburton (HAL), the largest North American pressure pumping player, and BJ Services (BJS), one the largest in this category, need to be avoided. We also have Sell recommendations for Nabors (NBR) and Patterson-UTI (PTEN), two major North American land drillers.