Highlights include Exxon Mobil Corp. (XOM), Schlumberger, Ltd. (SLB), Transocean Ltd. (RIG), Nabors Industries Ltd. (NBR), Patterson-UTI Energy Inc. (PTEN), BJ Services Co. (BJS), XTO Energy Inc. (XTO) and Chesapeake Energy Corp. (CHK).

Oil prices have moved up impressively in the recent past, up almost 18% in the last four weeks alone, and currently at the highest point in 2009 at close to $58 a barrel. The S&P 500 has gained around 11% in the same time frame, though its overall gain from the March lows is fairly impressive. The equity market rally reflects the growing optimistic narrative about the economic landscape, with sightings of 'green shoots' and favorable 'stress-test' outcomes. Today's favorable payroll numbers reinforce that outlook.

But what accounts for the oil rally, how sustainable is it, and what are its investment implications going forward?

There is limited, if any, fundamentals support in oil's supply and demand data. Inventories in the U.S. are at 18-year highs and remain bloated worldwide. Demand remains anemic and projections continue to come down. At current projections, global 2009 demand will be below last year's level, which itself was below the 2007 level; the first time since the early 1980's of two back-to-back negative growth years.

The only positive in this otherwise supply-demand picture is OPEC's success at taking a fair amount of oil off the market. OPEC's successful stewardship provided the commodity with a floor in Dec. '08 in the low $30's a barrel range.

Oil's recent gains reflect the same forces that are pushing the broader equity markets up. And that makes plenty of sense. At the end of the day, the demand for oil (or any other commodity, for that matter) is a function of the health of the global economy. Oil's heavy carbon footprint, as a result, is unable to come in the way of its strong affinity for those 'green shoots' that are steadily emerging on the scene.

Oil should be able to hold onto its gains and consolidate around current levels provided this favorable view of the economy remains in place. In fact, in a major call yesterday, our economic team projected that the recession may actually have ended this month.

This emerging outlook has major implications for sub sector choices within the energy space. Historically, the large-cap integrateds (such as Exxon (XOM)) would outperform in a down trending oil price environment, owing to their low-beta and defensive postures. But these stocks lag in a consolidating and/or rising oil price market, as we have seen in the recent past. To better capitalize on this outlook, we would advocate a growing exposure to the large-cap service names (such as Schlumberger (SLB)) and deepwater drillers (such as Transocean (RIG)).

We remain wary of natural gas centric service players, such as Nabors (NBR), Patterson-UTI (PTEN) and BJ Services (BJS) who have moved up sharply in recent days.

Aside from natural gas' recent bounce back from its multi-year lows, another major reason for the strong performance of these stocks is the expected bottoming of the onshore U.S. rig count, as was indicated by a number of industry players on the first-quarter calls.

Our view is that a near-term rig count bottom would imply a level less than half of its August 2008 peak, meaning plenty of excess drilling capacity to keep dayrates and margins under pressure well into 2010. We would prefer playing the natural gas market through well hedged resource-play producers such as XTO Energy (XTO) and Chesapeake (CHK).