Investing in Oil and Gas

Sept. 12, 2000 -- 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 moremomentum than many tech names; thesecompanies should all crush Wall Street earningsestimates. Most importantly, they trade as if oilprices will soon return to the $18 to $22 per-barrelrange and natural gas prices return to the $2.50per-million-cubic-feet range. (Today, oil traded in the$35 range and natural gas in the $5 million cubicfeet range.)

UBS Warburg analyst Christopher Eades makesthe bull case pretty well in a recent report: “Despiteoil prices at close to peacetime highs and naturalgas prices at record highs, the E&P [exploration andproduction] companies continue to discount anoverly bearish environment. The roots of investorpessimism are easy to pinpoint. A basket of E&Pstocks bought at year-end 1988 and held throughyear-end 1999 would have realized a net return ofzero … Thus, most seasoned E&P investors havebecome accustomed to riding the group up and thenselling in anticipation of a coming correction.”

Boosting Price Forecasts

There are reasons to think that this time the recentpast will not be a prologue. Oil and natural gassupplies remain extremely tight, and OPECimpressed no one with its decision to increase dailyproduction by 800,000 barrels. Worldwide energydemand continues to grow, especially in Asia.

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

Now, I’m not an oil expert, but it seems to me thatthe Law of Large Numbers has got to come into playpretty soon. Here’s what I mean. Oil consumption iscurrently running about 75 to 80 million barrels perday. OPEC’s total production is about 25 millionbarrels per day. Let’s assume demand grows at 2 percenta year. Doesn’t seem like much, but 2 percent growth on abase of 75 million barrels per day means that inabout 10 years, new demand will consume justabout all of OPEC’s production.

That suggests to me that pressure on energy prices could continue forsome time. Yes, there will always be oil left todiscover, but they will need increasingly to be thesize of a Prudhoe Bay to absorb the growth inconsumption.

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 togo. After all, if oil prices remain higher than currentlyexpected — as reflected in current stock prices —they will all do well. Hey, this is a commoditybusiness in the main.

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

Now, PaineWebber has both trading interests andinvestment banking interests in many of thesestocks, but I liked the way Featherston emphasizedthe business fundamentals underlying his bullishcall.

He writes: “The fundamentals for the E&P sectorhave never looked better: Tight oil inventories bodewell over the next 18 months, natural gas priceshave shifted to a considerably higher trading rangeand managements are exercising impressivefinancial discipline. We believe this backdrop couldprovide a longer-than-average cycle.”

PaineWebber’s picks include: AnadarkoPetroleum, Apache, Barrett Resources, Burlington Resources, Devon Energy, EOG Resources, Evergreen Resources,Houston Exploration,Newfield Exploration, PatinaOil & Gas, Swift Energy and Triton Energy.

Most of these guys are medium to small players.They will either grow or be swallowed by bigger fishlooking for secure oil and gas reserves. That’s theway I think of them.

Brett Fromson writes daily for TheStreet.com. Inkeeping with TSC’s editorial policy, he doesn’t ownor short individual stocks, although he owns stock inTheStreet.com. He invites you to send yourfeedback to bfromson@thestreet.com.