At Energy conference, fund managers discuss drilling

,a href=www.vheadline.com>Venezuela Electronic News Posted: Friday, April 04, 2003 By: PETROLEUMWORLD

There was hardly a consensus of opinion among fund managers attending the Howard Weil Energy Conference in New Orleans about what is keeping energy stock prices down and discouraging capital spending on new projects. But most agreed that geopolitical uncertainty is buoying commodity prices, which in turn continues to take a toll on the stock prices.

At breakfast Wednesday, Fred Sturm, who manages a natural resources fund at Mackenzie Financial Corp. in Toronto, said he's trying to understand the lack of will to increase investments in drilling, given how high prices are.

"If you had told me a year ago that we'd have oil at $30 (a barrel) and gas at $5 (per thousand cubic feet) for the next year, and I'd be at the biggest energy conference and there would be no buzz, I'd have said no way," he said.

He believes preoccupation with the news from Iraq has made people lose sight of the longer-term scenario - that the US may well be digging itself into a severe supply shortage in natural gas by next winter. If producers were willing to pay more attention to the longer-term, they would make reserve replacement a priority, he said.

"If you really believe there's going to be a need for gas, why aren't you at the bank borrowing" to finance drilling more wells, he asked.

John Slavik, on the other hand, says he thinks it's just a matter of time before oil and gas prices fall, which will justify an exit from energy stocks by investors who have hung on this long.

"Everyone's overweight energy stocks but hesitant to get out because the (alternative) equities are weak," said Slavik, one of a team of managers who oversees a small-cap institutional pension fund at Westfield Capital Management in Boston.

Although he sees the persistence of high commodity prices as an overhang weighing on the market, he said a case can be made for oil and gas prices bottoming at higher levels than they have in the past.

Patrick Rowles, a portfolio manager at Kempner Capital Management in Galveston, Texas, took a different view on the widespread hesitation to commit dollars to drilling.

Many of the producers have hedged as much as 50% of their gas production, he said. That means they are only partly benefiting from the price spike in gas, earning something in the range of $3.50-$4.50 per thousand cubic feet rather than the full price.

"I expect to see a gradual improvement in the rig count as the hedges come off and they can capture more of the (higher price trend) in natural gas," he said.

Once a higher base price for natural gas between $3.50 and $4.00 has been established, Rowles said he believes the multiples at which E&P stocks are trading will start to improve. He predicts that will happen during the summer.

Another reason for the delay in drilling is the passing of the baton to a younger generation of chief executives, who are in their 40's and are more inclined to capital discipline than "drilling until they die," he said.

Even if commodity prices are due for a tumble, the option of selling production forward at current prices should be enough to quell producers' trepidation about spending money on drilling, according to a hedge fund manager who asked not to be named.

"You can hedge (gas) two years ahead at $5, so what's the problem?" he said.

Other people said two years' worth of production sold forward at current prices wouldn't generate enough profit to cover the cost of putting in new infrastructure and starting some operations from scratch.

Apparently, it is enough for Apache Corp. (APA), however, which said this week it would grow production by 29% in 2003 by developing organic reserves and recent acquisitions. It could be the independent E&P firm sees itself as being able to afford the investment, having hedged 200 million cubic feet of gas per day at a New York Mercantile Exchange price of $5.18 for 2003 and another 140 mcf/d at $4.52 for 2004.

Apache is one of the exceptions among independent producers, many of which are talking more about future development plays than how they plan to meet near-term production growth targets.

It's been more efficient for producers to replace declining reserves through mergers and acquisitions than through the drilling new wells, said Slavick, the fund manager at Westfield Capital Management. He expects to see a lot more consolidation among E&P players.

But the ones who remain in the game will have to start drilling at some point if they are going to replace their declining reserves, he said. He predicts drilling will pick up significantly within the next six months, once the bottleneck in natural gas supply kicks in.

And if it doesn't, Fred Sturm at Mackenzie Financial Corp. said he has another piece of advice for US consumers: they should do themselves a favor by buying an electric heater this summer, because he doubts there will be any to be found next winter.

By David Bogoslaw, Dow Jones Newswires; 201-938-5289;david.bogoslaw@dowjones.com