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THE WALL STREET JOURNAL: Oil Expert Is Still a Fan

By SANDRA WARD
April 2, 2006
After three booming years in the energy sector, investment bargains still can be found although oil and natural gas prices are expected to level off this year, according to respected oil-patch analyst Art Smith, chairman and chief executive officer of research firm John S. Herold Inc., of Norwalk, Conn., and Houston.
Valuations, especially among the large multinational companies, continue to look compelling based on earnings and cash flow. Mr. Smith points to ConocoPhillips, Exxon Mobil, Chevron, BP and Royal Dutch Shell as examples of top-flight energy companies trading at between 6 and 11 times earnings even though they should continue to generate gobs of cash flow if oil and gas prices stay flat.
“Overall, the big integrated oil companies' earnings power continues to surprise us,” says Mr. Smith, “and they are enjoying something they haven't seen before: upstream profits [from finding and producing oil and gas] at an all-time high at the same time refining and marketing is also generating some of the best returns in recent years.”
The stock market continues to discount the companies and place a much lower price tag on them than exists in the forward market for oil and gas. The current 12-month strip, or the average price for contracts in the next year, is $65 a barrel for oil and nearly $9 per million BTUs for gas. Yet, says Mr. Smith, the stock prices for Anadarko Petroleum, Kerr-McGee and Pioneer Natural Resources and others imply an oil price of about $45 a barrel and a natural-gas price of $6 per million BTUs, much less than the consensus view of where prices are headed eventually.
That's an indication of profound investor cynicism toward energy pricing, though the futures market has correctly pointed to the price gains of the past three years, notes Mr. Smith.
Despite his outlook for flat pricing this year, he believes there will be another major surge in prices at some point, based on demand trends and supply limitations. The discrepancy between stock prices and energy futures is likely to result in more companies seeking to unlock share value by recapitalizing. “Their balance sheets have gotten so strong, a compelling theme for companies is to borrow money,” buy back stock, “and then deleverage [reduce debt], which drives the stock price,” says Mr. Smith, adding that Cimarex Energy is a likely candidate for a leveraged recapitalization.
He cautions, however, that a tinge of speculation has entered the oil-field equipment and drilling sector in the form of orders for new offshore rigs and oil-field equipment and notes, too, that cost inflation is soaring as parts and labor are in short supply.
Sandra Ward is a senior editor of Barron's magazine, which is found online at www.barrons.com.

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