Investing in Oil and Gas

What significant new trend could make you serious

money? The common answers today: broadband or

wireless. But let me suggest another — oil and gas

exploration and production companies.

Don’t laugh. Some of these stocks have more momentum than many tech names; these companies should all crush Wall Street earnings estimates. Most importantly, they trade as if oil prices will soon return to the $18 to $22 per-barrel range and natural gas prices return to the $2.50 per-million-cubic-feet range. (Today, oil traded in the $35 range and natural gas in the $5 million cubic feet range.)

UBS Warburg analyst Christopher Eades makes the bull case pretty well in a recent report: “Despite oil prices at close to peacetime highs and natural gas prices at record highs, the E&P [exploration and production] companies continue to discount an overly bearish environment. The roots of investor pessimism are easy to pinpoint. A basket of E&P stocks bought at year-end 1988 and held through year-end 1999 would have realized a net return of zero … Thus, most seasoned E&P investors have become accustomed to riding the group up and then selling in anticipation of a coming correction.”

Boosting Price Forecasts

There are reasons to think that this time the recent past will not be a prologue. Oil and natural gas supplies remain extremely tight, and OPEC impressed no one with its decision to increase daily production by 800,000 barrels. Worldwide energy demand continues to grow, especially in Asia.

And from the Wall Street angle, analysts are scurrying to boost price forecasts for oil and gas. And I would bet that most investors are underweighted in the area — meaning they own fewer oil and gas names than the benchmarks they use to measure their relative performance. All that bodes well for the E&P group.

Now, I’m not an oil expert, but it seems to me that the Law of Large Numbers has got to come into play pretty soon. Here’s what I mean. Oil consumption is currently running about 75 to 80 million barrels per day. OPEC’s total production is about 25 million barrels per day. Let’s assume demand grows at 2 percent a year. Doesn’t seem like much, but 2 percent growth on a base of 75 million barrels per day means that in about 10 years, new demand will consume just about all of OPEC’s production.

That suggests to me that pressure on energy prices could continue for some time. Yes, there will always be oil left to discover, but they will need increasingly to be the size of a Prudhoe Bay to absorb the growth in consumption.

A Starting List of Investments

I’m sure there are a ton of good stocks in the area. And a large number of names may be the way to go. After all, if oil prices remain higher than currently expected — as reflected in current stock prices — they will all do well. Hey, this is a commodity business in the main.

That said, I searched to find some names for you to consider. PaineWebber oil and gas analyst William Featherston had a good list to get you started in a report he put out on Sept. 5.

Now, PaineWebber has both trading interests and investment banking interests in many of these stocks, but I liked the way Featherston emphasized the business fundamentals underlying his bullish call.

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