Dramatically higher oil and gas prices produced significantly more profitable operations in the first half for midcap oil companies as much as for majors and large independents, according to Petroleum Finance Week's "Midcaps at Midyear Scoreboard." The 24 companies studied this year increased their total operating income by 357.5% on revenues that climbed 61.8% year-to-year during the first half. Dramatic improvements did not occur in every case. Wall Street oil analysts say that hedging probably had the biggest negative impact on some companies' results. "Some of the more financially leveraged companies had to lock in part of their production to provide base cash flow to make interest payments. So they missed a lot of the price upside," says Michael C. Schmitz, who follows midcaps for Salomon Smith Barney, New York. "The ones that already had reduced debt were able to keep cost structures lean and bring increased commodity prices directly to the bottom line." "It's a mixed bag so far, caused by the quality of the companies," adds his colleague, Robert Morris, who tracks larger independents. "Recently, there was a little catch-up. But the bigger-cap names tend to take the lead. A lot of it has to do with market cap and liquidity. Some investors want to be able to move into and out of a stock quickly, so they go for the bigger names at first. But they start to pay more attention to midsize and smaller producers as they grow more confident." Stone Energy Corp., Louis Dreyfus Natural Gas Co., Pogo Producing Co., Vintage Petroleum Corp., Cross Timbers Oil Co. and Triton Energy Ltd. fell out of PFW's midcap study group this year because their market caps improved to more than $1 billion. Three other producers fell out, with market caps declining below $250 million: Evergreen Resources Inc., Harken Energy Corp. and Permian Basin Royalty Trust. Among arrivals, Pure Resources Inc., the Titan Exploration-Unocal Permian combination, debuted near the top of the scoreboard with a nearly $913-million market cap. Swift Energy Co. came into the group with a more than $590-million market cap, up 175% from $214 million a year ago. Other new members are Hugoton Royalty Trust, Clayton Williams Energy Inc., Basin Exploration Inc., Prima Energy Corp., Nuevo Energy Corp., Patina Oil & Gas Corp., Belco Oil & Gas Corp., Denbury Resources Inc., Pennaco Energy Inc., The Meridian Resource Corp. and the BP Prudhoe Bay Royalty Trust. The outlook for the group is more bullish than in years. "The midcaps have outperformed the large caps, and the small caps have done even better," says John Myers of Dain Rauscher Wessels in Austin. "Their stock performance is up about 70%, year-to-date. Investors are starting to take more notice. Also, the companies are doing a better job. Unlike the last cycle, when producers spent more than their cash flows, the companies are paying down debt and repurchasing stock while growing production. Wall Street likes that. It complained about lack of financial returns from this group for two years. Now, it's seeing some real value being built." Wayne Andrews, who follows midsize independents for Raymond James & Associates Inc. in Houston, says, "It's a recurring theme. They've decided to be more constrained. Instead of chasing volume for volume's sake, which did not impress investors during the last cycle, independents are trying to generate higher rates of return. If they continue to use the low price decks they have for the last couple of years, I think they'll do very well. They'll only run into trouble if they start using $5 gas and $30 oil prices for their assumptions." "We went through a period where the investment community really beat this group up, and the stock prices still haven't recovered fully," says Morris. "They're still sensitive, even with $5 gas and $30 oil on the screen. They're using price decks of $22 for oil and $2.25 for gas, so their returns at today's prices are tremendous. Some of these companies are posting returns of more than 100% on some of their projects." Several producers also did not have prospects in their portfolios to pursue as their cash flows improved. "Many of them simply didn't have prospects ready to drill. They also don't have professionals capable of generating prospects quickly any more. So they put money aside to buy back stock and improve their balance sheets," says Schmitz. Analysts' outlook is exceptionally bright for producers. "By and large, most of the industry is pretty much unhedged going into 2001. The companies whose results didn't look good in the first half will look a lot better as their hedge positions roll off," Myers says. -Nick Snow