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Pace of E&P Acquisitions, Upstream Investment Expected to Pick Up -- Herold Study

With so much money on the table and no other logical outcome, the pace of mergers and acquisitions among oil and natural gas companies will pick up again this year, and capital investment in the upstream sector will grow by at least 25%, according to a new report by energy research firm John S. Herold Inc.

In a 28-page 2005 year-end review on Peer Group Stock Market Performance, Herold researchers Robert E. Gillon and Kathryn B. Berger said energy investors worldwide enjoyed their fourth year in a row of prosperity, with market capitalization of the group soaring by about $500 billion. "Without a doubt, total wealth generated is both eye-popping and exceeds all previous years," they wrote. Median total return was 44%, compared with 50.8% in 2003 and 39.2% in 2004.

After taking into account "all that is knowable," the market is projecting crude oil and North American natural gas prices "will be little changed in 2006. For what it's worth, we agree," said Gillon and Berger. "We're also near certain that both the market and ourselves will be wrong. Swings of more than $15/bbl and $3/Mcf during the course of the year should be expected, and it simply would be a coincidence if the closing prices are close to the present levels."

The researchers suggested world energy consumption will lag forecasts this year, "at the same time that oil production from Canada, West Africa and Russia will be building, as will Asian natural gas output. Traders' mind sets could easily shift from perceived shortage to glut. Fifteen dollar gas -- what fool thought that was possible?"

Total capitalization of the industry exceeds $2 trillion, with more than half in the six largest producers: ExxonMobil, BP plc, Royal Dutch Shell, Total SA, Chevron Corp. and ENI spa. Each are worth more than $100 billion, however, "for a variety of reasons, the primary one being that they have limited production growth prospects, these companies have lagged the rest of the industry in each of the last six years."

On the other hand, oil and gas reserves developed with relatively low technical risk, such as oil sands and tight gas reservoirs, "are particularly desirable now that capital is abundant and prices are expected to remain lofty. Companies of this sort are the opposite of prospect constrained. [Calgary-based] Suncor Energy has exploited its synthetic oil mine niche for over 10 years, and [Houston-based] Burlington Resources' asset base prompted ConocoPhillips' acquisition bid" (see NGI, Dec. 19, 2005).

For the fourth straight year, the larger North American producers outperformed all broad market indices and integrated oils. The median return at 59.4%, "is sensational, particularly since it follows gains of better than 40% in each of the prior years...$50 oil and $9 gas has changed investor's perception of the group." North American producers led "as unconventional natural gas fields and bitumen reserves became desirable assets."

Of the 383 worldwide producers reviewed, Herold noted 13 had more than tripled in price during 2005, and 50 doubled in price, similar to 2004 results. North American-based leaders included some that have had less press coverage than their peers: GMX Resources Inc. (416.5%), Arena Resources (224.7%), Parallel Petroleum Corp. (215.6%), Frontier Oil (181.5%), Southwestern Energy Co. (183.6%), Paramount Resources (154.9%), Vintage Petroleum Inc. (135%), and Nexen Inc. (134.9%).

By peer group, Herold wrote, "the Canadian market was almost as profitable a place to invest as Moscow this past year." For the third straight year, Canadian independents, integrated oils and royalty trusts outperformed their U.S. counterparts. Connacher Oil & Gas, a new heavy oil patch player, led the E&Ps, while Husky Energy was the top integrated oil and Canadian Oil Sands Trust had the best return among income vehicles.

Within the group of North American Super Independents, Canadian-based Nexen Inc. nudged out Canadian Natural Resources for top honors. Vintage was tops in the Large U.S. Producer category, edging out Ultra, whose shares have jumped 149%, 96% and 132% in the past three years. Southwestern Energy, which has more than doubled three straight years has "clearly moved itself up into the next size category." And GMX Resources, which ranked third in the category, has East Texas gas prospects exciting investors.

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