May you live in interesting times, say the Chinese. We certainly are today. This unique business climate, one we have never seen before, is strangely characterized by four major disconnects. These are the gap between oil and gas prices, between the federal government and the industry, between high oil prices and low energy stock values and finally, between the so-called old economy and the new economy. For about a year now, oil prices have soared while natural gas prices have been left in the dust, so to speak. Only lately has gas risen higher, and luckily, in spite of a warm winter. Analyst Eugene L. Nowak of ABN-Amro has raised his gas price forecast to $2.35 per thousand cubic feet, which is also his price for 2001. He thinks the majors he follows, as a group, will report earnings 50% above last year. It should not be surprising that we have seen the two Bills, President Clinton and Energy Secretary Richardson (not to mention several Congressmen), pleading with OPEC to increase oil production and bring down high prices. Why were their cries barely audible 12 months ago, when domestic oil producers were gasping for air? The price of oil is based on supply and demand-it's not a strictly free market concept, however, as we know who is manipulating supply. For a congressman to introduce legislation prohibiting U.S. military aid to any country (Saudi Arabia and Kuwait) that manipulates oil prices upward by withholding supply is ludicrous-just as it would be crazy to punish any producers that manipulate oil prices downward. Then, there's the gap between oil prices and stocks. Analyst David C. Bradshaw at Donaldson, Lufkin & Jenrette, never at a loss for local color, says the Filene's Basement valuation for the independents is out of sync with the realities of the individual company stories. He expected big fireworks when the group reported fourth-quarter earnings, but that didn't materialize-even though earnings were spectacular. (Filene's Basement is a wonderful discount chain based in Boston that New Englanders cherish for its great bargains, amidst messy counters trashed by eager shoppers who fling merchandise left and right.) "Sagging share prices going against operational progression have pushed valuations to ludicrous levels," says Bradshaw. His group was trading recently at 4.6 times total capitalization to 2000 mark-to-market EBITDA-versus a range of 5 to 9 times seen since 1990, when oil and gas prices were not nearly as robust. Salomon Smith Barney analyst Paul Ting points out that in February 2000, when oil was about $30 a barrel, the majors traded below February 1999 prices, when oil was $12 to $14 per barrel. Obviously, this doesn't make sense. He thinks these stocks will perform well once oil prices drop later this year. A theory circulating among analysts right now is that investors have been evaluating E&P stocks incorrectly in the first place. Howard, Weil, Labouisse, Friedrichs suggests they look at fair market value and return on capital. Raymond James & Associates' John J. Gerdes says they need to look at six things: industry dynamics, asset type (percent of proved undeveloped reserves), accounting issues, performance measures such as finding costs, capital structure, and finally, traditional factors such as trading multiples, net asset value and commodity prices. Petrie Parkman & Co. advocates focusing on free cash flow. (See the guest article on the matter in this issue.) For whatever reason, and despite impressive fundamentals and company specifics, investors are yawning. Why should they wait for the E&P companies to report solid results for another two quarters, or wait for the service industry to right itself, when the high-tech, telecom and biotech stocks are delivering more dollars than a dozen Santas? The economy has changed drastically, or so they tell us. According to Business Week, 13 of the top 25 American companies were in the energy sector in 1979 and just three technology companies were on the list. By December 1999, however, only Exxon Mobil made that list, and technology companies held 13 of the top 25 spots. That's ironic. Apparently, drilling four miles deep and three miles laterally, through extremely high temperatures and pressures, to extract oil from miniscule pore spaces at the rate of hundreds of barrels per day is not "high tech" enough in the public's mind. Somebody ought to be able to sell the oil industry as being very high tech. Let's hope the annual "Howard Weil Effect" kicks in again this year, and soon, to push energy stocks higher. Attendees at this year's 28th annual conference in New Orleans should hear some incredibly strong stories. And many of the E&P companies are buying back their own stock to further bolster valuations. After all, they are in essence buying back a bigger interest in the very oil and gas reserves they know so well.
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