2001 was a good year for U.S. independent producers. Despite a fairly steady drop in oil and, especially, North American natural gas prices through the final months, many exploration and production companies showed record revenues and earnings. Several began 2002 with much higher production and significantly stronger balance sheets. Alas, their stock prices did not fare as well. The independent-producer segment of the Petroleum Finance Week Index, which tracks prices of 36 large, midsize and small E&P companies' stock, finished last year at 1,812.08. That was 563.2 points or 23.7% lower than the year-end 2000 figure of 2,374.28. The decline reflected an increasingly negative investor attitude toward producers, which was caused more by forecasts of falling demand due to a weak economy, than by the sliding commodity prices or company fundamentals. But upon closer inspection, it is clear that larger institutional investors apparently took a longer-term view. Whether they smelled bargains as some stock prices retreated, or continued to believe in longer-term fundamentals, the 25 top fund managers increased the number of E&P common shares they held by 2.9% during 2001, according to Oil and Gas Investor's exclusive examination of their Form 13F filings with the Securities and Exchange Commission. Their new E&P investments actually rose more than 2.9% year-to-year if factoring that they also replaced more than 24.6 million common shares of 10 independents that disappeared through acquisitions during 2001. And, as always, there was a lot of movement during the year. FMR Corp. (Fidelity) cut its E&P holdings 36%. But Merrill Lynch held 23 more independents at year-end 2001 than it did the previous December 31. And, Massachusetts Financial Services Co. increased its E&P holdings by 45 million shares, nearly tripling its stake in E&P companies. The survey measures the number of common shares held instead of dollar value because stock prices change dramatically and frequently. It excludes debt and options. It does not differentiate between a normally higher price of a large producer's common stock relative to its smaller competitors' equities. But it does reveal investors' relative concentrations, equity-by-equity, and suggests their approaches to buying, selling and holding E&P stocks. The study includes companies with operations beyond E&P, but whose executives have positioned their firms primarily as oil and gas producers. That explains the presence of Amerada Hess Corp. and Murphy Oil Corp., which have refining and marketing operations. Unocal Corp., Kerr-McGee Corp. and Southwestern Energy Co. also have non-E&P segments, but consider themselves independents. Not surprisingly, familiar E&P names dominate the tallies. But size in and of itself did not necessarily guarantee that large investors would continue to hold the same number of shares. Amerada Hess, for example, dropped from eighth to 11th place despite significant additions to its E&P operations that included the acquisition of Triton Energy Ltd. When a fund reduces the total shares it holds in an E&P company, that doesn't necessarily imply a corresponding decline in confidence in management. Rather, it may reflect a change in its assessment of the equity's near-term growth potential, or the fact that a successful company's stock may have climbed enough to be fully valued relative to other choices. These are primary reasons why increasing production and reserves don't always translate into higher equity prices. And after September 11 as the economy deteriorated, many investors felt compelled to flee to larger companies with more liquidity and perceived safety. In some cases, the increase in equity holding was due to convertible debentures that converted to common stock during the year. For example, that was the case for Swift Energy Co. of Houston, says Bruce H. Vincent, executive vice president. Or, a change in share ownership may result from a change in the philosophy of the fund itself, irrespective of what the energy industry is doing. "Zurich Scudder was at one time our largest shareholder, but late last year it was acquired by Deutsche Bank," explains Vincent. "Since then, the new parent has asked it to realign its portfolio [for various internal reasons], and as part of that it significantly reduced its ownership in SFY, although they still hold close to 1 million shares." On the other hand, other large funds have increased their holdings in Swift. Most E&P companies have dedicated themselves to tracking who owns them, who does not and who owns their peers. "We get reports every month on who is buying and selling Swift and we look at different types of investors-value, growth, momentum, growth-at-a-reasonable-price or GARP-to target the right kind of investor for us," says Vincent. "Every year we develop a business plan in terms of marketing trips, analyst contacts and conferences. Instead of selling widgets, a public company is selling its stock-you've got to know your customers and what affects their decisions." Bill Transier, Ocean Energy chief financial officer, also tracks investor activity-internally and through Thomson Financial Group-by type of investor. "Every month I talk to the board about our investor base." Ocean's strategy includes trying to differentiate itself from other E&P companies. It monitors the momentum players. "And we have also focused on getting more European investors, who tend to stay with you longer," Transier says. "You can have a great company and a great management team, but if you don't get your message out, you won't get anywhere." Those efforts must be paying off-the survey indicates that last year, Ocean moved into the No. 8 spot among E&P companies. The number of OEI shares held by the top 25 funds rose by 11.3 million shares. Top E&Ps held In 2001, Anadarko Petroleum Corp. held on to first place in investor popularity among independents, despite an 11.5% drop in the number of shares held by the 25 large funds, to 77.3 million shares from 87.4 million. Unocal moved past Burlington Resources Inc. into the No. 2 spot. Apache Corp. stayed in fourth place, but narrowed the gap between itself and Burlington with nearly 17.7 million more of its common shares in the large investors' portfolios year-to-year. Devon Energy Corp. came in fifth as the large funds increased their stake in the Oklahoma City firm by more than 8 million common shares. But it was Westport Resources Corp. in Denver that enjoyed the biggest meaningful year-to-year percentage gain. The large funds held more than 3.4 million additional shares, or 276% more of its common equity in 2001-a year when Westport become one of the top U.S. independents with its August acquisition of Belco Oil & Gas Corp. "I think the increase was mostly due to Belco because of the larger size it made us, and because we went on an extensive road show to explain the new company," says chief financial officer Lon McCain. "Certainly some of the Belco shareholders stayed with us. Then in December we were on the road again for our high-yield bond offering. There was some overlap in our equity- and bondholders, so some of the equity-holders attended the second road show as well." In addition to Belco, nine other domestic E&P companies disappeared from the table because they were acquired. Two Denver independents, Pennaco Energy Corp. and Barrett Resources Corp., led the list as they were consumed by Marathon Oil Corp. and The Williams Cos. Inc., respectively. Williams was not the only diversified energy supplier to raise its E&P profile last year. Dominion Resources Co. added gas-rich Louis Dreyfus Natural Gas Corp. to its E&P holdings that already included the former CNG Producing Co. and Wolverine Oil and Gas Co. Kerr-McGee, meanwhile, added significantly more gas production to its arsenal with its purchase of HS Resources Inc. of Denver. After the deals, the funds replaced these holdings with shares of other independents. They built new positions of 423,343 shares in newly public ATP Oil & Gas Corp., 301,800 shares in Ultra Petroleum Inc., 230,009 shares in PYR Energy Corp. and 190,000 shares in Contango Oil & Gas Co. They also increased their stakes in Vintage Petroleum Inc. by nearly 1.8 million shares, Cabot Oil & Gas Corp. by more than 1.7 million shares, and Forest Oil Corp. and Patina Oil & Gas Corp. by more than 1.5 million shares each. And they added close to 1.4 million shares each of St. Mary Land & Exploration Co. and Meridian Resource Corp., and 1.1 million shares each of Swift Energy Co. and Pogo Producing Co. Reductions offset other equity additions. What fund leaders bought Although the 25 funds increased their total domestic E&P holdings 2.9% to nearly 775.9 million common shares at the end of 2001, individual fund adjustments varied widely. Massachusetts Financial Services Co.'s overall increase was the most dramatic. It leaped from 19th to second place with a 294.3% jump of more than 45.1 million shares. It makes large investments in a small group of independents that grew smaller as some positions rose dramatically and others were cut. Barclay's Global Investors rose from third to first place as it added more than 12.9 million common shares of domestic upstream independents. It held stock in 65 companies, in contrast to MFS, which owned shares of only nine at the end of 2001. Barclay's dislodged FMR Corp. (Fidelity), which dropped to the No. 5 position after reducing its domestic upstream equity holdings by almost 26.4 million shares, or 36.2%. It slashed its holdings in Burlington Resources by nearly 11.4 million shares, or 55.7%, and in Devon Energy by almost 6.3 million shares, or 62.4%. Fidelity also reduced its holdings in several other large U.S. independents, offset only partially by increases in its Amerada Hess and Murphy Oil positions. Wellington Management Co. LLP dropped to third place as it reduced its U.S. E&P common stock total by more than 16.8 million shares, or 23%. There were significant changes upward and downward in several of its holdings year-to-year. Capital Research & Management Co. held on to its No. 4 position as it raised its domestic upstream equity total by nearly 5.5 million shares, or 11.5%. The Mellon Bank division of Mellon Financial Corp., at No. 6, added almost 4.4 million shares or 10.8%, to its year-end total of nearly 45 million shares in 74 companies. Its five new positions focused on small-cap independents including ATP, Encore Acquisition Co., Energy Partners Ltd., Quicksilver Resources Inc. and Goodrich Petroleum. Although its domestic E&P common stock total grew by nearly 3.7 shares to more than 42 million shares of 45 companies, seventh-place State Street Corp.'s changes were more like adjustments. But last year it also took new positions in two Nasdaq-listed firms-PetroQuest Energy Inc. and 3Tec Energy Corp. T. Rowe Price Associates Inc., at No. 8, increased its U.S. upstream equity holdings by nearly 8.1 million common shares or 23.7% last year. Its approach was the opposite of State Street's as it eliminated positions in Brigham Exploration Co., EEX Corp., Pogo Producing Co. and Southwestern Energy outright. But it more than offset those disposals with new stakes in Mitchell Energy, Westport Resources, Newfield Exploration, McMoRan Exploration Co., Nuevo Energy Co., Pure Resources Inc. and Spinnaker Exploration Co. Vanguard Group Inc., at No. 9, increased its U.S. E&P holdings by 7.2 million common shares or 22.1% during 2001, to almost 40 million shares in 71 companies. The biggest of its 15 new positions were 335,600 shares of PetroQuest Energy, 256,000 shares of ATP, 112,500 shares of Abraxas Petroleum Corp., 86,900 shares of The Exploration Co. and 40,264 shares of Toreador Resources Corp. AXA Financial Inc., at No. 10, upped its holdings by 7.1% by adding more than 2.1 million common shares to its domestic upstream equity holdings. Its nearly 32.2 million common shares of 43 companies included eight new positions, led by 155,700 shares of Wiser Oil Co., 85,100 shares of Vintage Petroleum, 36,100 shares of St. Mary L&E, 5,300 shares of Encore Acquisition Co. and 3,000 shares of Comstock Resources Inc. Making adjustments Other funds' strategies became apparent in the changes of their holdings. Putnam Investment Management LLC seemed to offset reductions in six domestic E&P companies with additions in five others. The approach extended to large producers, where Putnam ended 2001 with 4.5 million more shares of Burlington and 4.2 million fewer shares of Apache than a year earlier. It also reduced its equity holdings in Anadarko by 3.8 million shares and Devon by 2.3 million shares, but added 3.3 million Unocal shares and 1.2 million of Vintage Petroleum. Goldman Sachs Group grew as aggressively in some stocks as it sold in others. It replaced four producers that merged or were acquired with new positions in five others, including 190,000 shares of Contango and 135,100 shares of KCS Energy Inc. Merrill Lynch held stock in 23 more independents at the end of 2001 than it did at the end of 2000. With the exception of 216,457 common shares of St. Mary L&E, 124,330 shares of Vintage Petroleum and 100,000 shares of Carrizo Oil & Gas Inc., its 28 new positions were relatively shallow. Even the reported totals of the funds' individual common equities did not tell the entire story. Morgan Stanley reported a total of 6.6 million Anadarko shares in its 2000 year-end SEC Form 13D filing. But the stock was held through 21 entities, with stakes ranging from 2- to 5.6 million shares. Clearly, there are nearly as many approaches to investing in U.S. exploration and production as there are fund managers-and the positions are subject to change.