The market capitalization of global energy companies soared by $500 billion for the second straight year in 2006, and investors enjoyed a fifth consecutive year of gains, according to a year-end study by energy research and consulting firm John S. Herold. However, the exploration and production (E&P) sector languished as natural gas prices lagged expectations.

Herold’s Robert E. Gillon, Kathryn B. Berger and Bryan McNamara noted in their 28-page “Peer Group Stock Market Performance: The Generals Move to the Front,” that 2006 had started off well, with a broad-based gain of nearly 6% in 1Q2006, and “winners outnumbered losers” two to one.

“In 2005, we heard that gas prices had risen so much that pipelines would be built to the Mackenzie Delta, Prudhoe Bay and the interior of Papua New Guinea so that production could finally start,” the authors noted. “This year we heard that pipeline costs had risen so much that the gas was going to sit there, after all. We heard that the industry had found billions of barrels of oil in the Lower Tertiary trend in the Gulf of Mexico, but that the wells are 30,000 feet deep in water depths of 6,000 feet. Nothing comes cheap anymore.

“We heard that Europeans are outbidding Americans for Trinidad’s LNG [liquefied natural gas]. For the first time in twenty years we heard talk of oil shale in the Rockies, this time extracted using microwaves. We hard investors were ‘shocked. shocked’ when the taxman changed the rules in Canada. But at the end of the year, despite the cost pressures and fiscal threats, the industry and its investors had a very profitable twelve months.”

The Herold trio declined to offer a forecast on natural gas prices.

“[New York Mercantile Exchange] traders say better days are coming, with the 12-month strip now at a lofty $7.22, but these are the same guys that said the average price would be $10.80 for 2006. We don’t forecast prices — we’ll just offer some observations. U.S. production continues to decline, Canadian exports are also heading lower, while Trinidad LNG gets shipped to Spain, not here, so long as European markets will pay more for spot deliveries. Meanwhile, numerous operators are curbing capital programs in view of high finding costs. Any further weakness in gas prices will be a temporary phenomenon, especially if crude prices stay healthy.”

Last year, the authors said, “expectations of an extended period of above-average profits drove the shares of integrated oils, natural gas distribution companies and independent refiners higher through 2006. However, E&Ps drifted downward along with gas prices through the next six months while the integrated oils powered higher, buoyed by rising equity markets. The fourth quarter brought gains to most of the peer groups, underpinned by expectations that oil supplies would remain tight through 2007.”

Denver-based MarkWest Hydrocarbon, the general partner of MarkWest Energy, led Herold’s 400-company peer group with a 146.7% total return in 2006, driven by rising earnings and a larger share of the enhanced distributions from its midstream subsidiary.

Median performance of 6.4% was posted by another Denver-based gas-directed company, Delta Petroleum, which is exploring for natural gas below the basalt in the Columbia River Basin of Washington. Delta also explores along the Gulf Coast and in the Rocky Mountains.

For the seventh straight year, the median shareholder return of the integrated oils, at 21.1%, bettered most of the major market indices. Total market capitalization jumped by more than $490 billion, pushing the value of the group to more than $2.5 trillion. ExxonMobil Corp., with a 38.7% return, contributed 20% of the market value increment, and it now has a capitalization equal to that of the next 20 largest E&Ps.

The largest producers posted their fifth straight annual gains, but the group overall trailed integrated oils and the broad market averages, lagging for the first time since 2001. The producers’ median return of 2.6% was small in comparison with the prior three years, which ranged between 40% and 59%. Posting double-digit gains for four consecutive years are Occidental Petroleum Corp. and Noble Energy, the top-performing North American entities.

Of the group, only nine stocks doubled in price, compared with the 50-70 that did so in the prior three years. For the first time since 2001, “nary a company tripled. It’s hard to get rich quick in the oil business, despite what some folks might tell you,” the study said. Besides MarkWest, North American-based companies that also gained substantially in 2006 included Contango Oil & Gas, up 108.4%; Exploration Co. of Delaware, 106.5%; and Petrobank Energy & Resources, 98.5%.

Canadian-based Nexen Inc. was the only company to rank in Herold’s top third for two years in a row, and it also repeated as the top-performing Canadian E&P. XTO Energy made the top third for the sixth year out of seven, earning the “consistency” award. XTO’s capitalization has jumped almost nine-fold since the end of 2001. North American-based gainers also included Plains Exploration & Production, up 19.6%; Canadian Natural Resources, 8%; Devon Energy, 8%; Forest Oil, 7.7%; and EnCana Corp., 2.6%.

Thirteen of the stocks suffered declines, up from just one in 2005 and none in 2003 and 2004. In North America, Pioneer Natural Resources slid 22.1%, “a dreadful performance made worse by the fact that the company has languished in the bottom third each year since 2002,” the study said. Cimarex Energy repeated in the bottom third, and “Anadarko Petroleum has nothing apparent to show in value added through its big acquisitions.” Anadarko’s returns dropped 7.4%.

Other North American E&Ps posting declines included EOG Resources, down 14.6%; Ultra Petroleum, 14.4%; Newfield Exploration, 8.2%; Chesapeake Energy, 7.7%; Talisman Energy, 3.2%; Southwestern Energy, 2.5%; Apache Corp., 2.3%; and Pogo Producing, 2.1%.

For more information on the report, visit www.herold.com.

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