Energy: Hitch Your Wagon To A Wildcatter

Forget refiners and focus on outfits that are finding oil and gas

Energy demand is climbing. New supplies are difficult to find. And the consensus on Wall Street is that oil and natural gas prices will remain high -- above $35 a barrel and $5 per thousand cubic feet -- for the foreseeable future. Given that tightening scenario, energy investors should direct their dollars to the companies that are out there feverishly looking for more oil and gas, unencumbered and undistracted by other businesses, such as refining or chemicals. These are the independents, the new wildcatters -- the folks with mud on their boots.

One hungry independent is XTO Energy Inc. (XTO ). Since the start of 2004, this Fort Worth outfit has spent $3.2 billion buying properties in Texas, Wyoming, Utah, and New Mexico. XTO targets existing fields with oil and gas reserves that are being slowly depleted. It aggressively drills new wells in these fields, hedging its bets by selling half of the anticipated production in the futures market. XTO will spend $935 million this year developing its properties, a 45% increase from 2004's drilling budget. The company is a favorite of veteran energy investor Douglas G. Ober, who manages the Petroleum & Resources (PEO ) fund. He figures XTO will meet its projected 25% production jump this year and continue to grow at a better-than-15% rate beyond that. "Given the declines you're seeing in existing fields, few people are doing that," Ober says.

While XTO is out buying, Oklahoma City-based Devon Energy (DVN ) has sold more than $2 billion worth of higher-cost properties in the U.S. and Canada in the past year. It's pumping some of that money back into deepwater exploration wells in the Gulf of Mexico, West Africa, and Brazil. As it develops these fields, Devon expects its oil and gas production to climb at least 5% annually over the next five years. The typical major oil company raises its production at about half that rate.

Other companies prefer to drill in their own backyards. In the past few years Houston-based Southwestern Energy Co. (SWN ) has quietly been acquiring drilling rights in the Fayetteville Shale region in western Arkansas. The company's land grab, which tops 755,000 acres, now looks like it was a good bet. Southwestern has drilled 39 wells in the region, of which 27 are producing, 8 are in development, and 4 were not productive. "Some of those wells tested at 3 million cubic feet [of natural gas] per day," says Thomas P. Schindler, co-portfolio manager at Diamond Hill Small Cap fund (DHSCX ). He thinks the new prospects alone are worth $20 per share, a little more than half of the current stock price of $37. The company has a good track record of adding new reserves. Over the past five years, Southwestern has found more than twice as much new oil and gas as it has produced. And that production has doubled over the same period, to 62 billion cubic feet of gas a year.

ROCKY MOUNTAIN HIGH

It won't be easy for Burlington Resources (BR ) to double its size. With the equivalent of 12 trillion cubic feet of natural gas reserves, the Houston-based energy company is one of the largest independents. It started out as the oil-exploration arm of Burlington Northern Railroad (BNI ), a legacy that left it with choice reserves in the Rocky Mountains. Spun off from the railroad in 1988, Burlington made a number of well-timed acquisitions in Canada. That country now accounts for about one-third of Burlington's production. It has also begun exploratory drilling in China and Algeria. Mark Freeman, director of research and portfolio manager at Westwood Management Corp. (WHG ) in Dallas, likes the fact that Burlington is being conservative with its cash. Since 2000, the company has bought back 10% of its shares, helping to boost earnings per share. Freeman figures the company will earn $5.10 per share this year. He has a target price of $70 for the stock, about 30% above Burlington's current share price.

At today's energy prices, filling up your tank and paying your winter gas bill stings. But owning a piece of an independent oil company might soothe some of that the pain.

By Christopher Palmeri

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