Greater Focus on Domestic Energy Expected as War Nears

While energy analysts remain shell-shocked following the brazen terrorist attacks on the nation's financial distriction and admit they have "no answers" for industry, some predict that the war-provoking events may cause the public, Capitol Hill lawmakers and investors to look more favorably upon North American energy producers, service companies and pipelines.

"The attack, and the U.S.'s certain retaliation in the Middle East region, we believe, will accelerate domestic energy providers' ability to grow, as various restraints placed on them are lifted out of sheer necessity. Also, it may be possible that public attitude toward oil and gas development in general will take a new turn -- from one of resistance to acceptance," said New York City-based FAC/Equities in an "Institutional Equity Research Flash" last Monday.

Ironically, this favorable climate for the domestic energy markets could come at a time when the industry may face a personnel crunch. Some employees in critical energy services reportedly already are either being called up as reservists or are notifying their companies that they intend to leave to join the military when the U.S. goes to war.

FAC/Equities believes that Congress, as a result of the crisis, will be more likely to act on a number of energy-friendly measures: 1) greater access to federal lands for drilling; 2) royalty relief for oil and gas production from federal lands; 3) tax credits for production from difficult, unconventional producing formations (i.e. tight or low permeable rocks, coal-bed methane gas and deep gas); 4) tax credits/royalty relief from stripper oil well production; 5) some access to drilling in the coastal region of the Arctic National Wildlife Refuge (ANWR); 6) higher allowed regulated rates of returns on interstate pipeline companies; and 7) reduced environmental and right-of-way restrictions on new interstate pipeline construction. A number of these measures are part of the energy package that passed the House before the Labor Day recess and are before the Senate for action.

"Onshore-oriented companies are largely favored by these changes, and geographically diverse companies that have operations skewed to the western, Rocky Mountain region are the most favored, in our view," said FAC/Equities. If the more than 90 million acres on federal lands in the Rockies that currently are closed are opened to drilling, it believes the exploration and production (E&P) companies that already are located in the region and possess a "working knowledge of the regional geology" will benefit the most, such as Anadarko Petroleum and Devon Energy.

In addition to Anadarko and Devon, FAC/Equities placed a "strong buy" on Apache, Burlington Resources, EOG Resources, Newfield Exploration, Pioneer and Western Gas Resources.

"Additionally, gas-field service companies that are already there with drilling equipment...and capable of benefiting from activity enhanced by tax credits or royalty relief that may occur," such as Key Energy Services and Unit Corp., will see much activity, FAC/Equities said. The same holds true for integrated interstate pipelines in the region that have large E&P operations, processing facilities and plan to build additional pipe capacity to access new supplies, it noted. Some of the companies it cited were Williams Cos., El Paso Energy, Questar Corp. and Western Gas Resources.

FAC/Equities also sees a more agreeable environment for natural gas prices, given the pressure that is likely to be placed on competing oil products. A "prolonged military action in the Mid-East could lead to a period of much higher world crude oil prices," which in turn "would [raise] the price of petroleum fuels that compete with natural gas -- specifically residual No. 6 fuel oil and distillate oil," it said. Resid tends to act as a ceiling for U.S. natural gas prices in large-volume, end-use markets, such as industrial and electric-utility boiler fuel markets. No. 2 oil has occasionally served as a substitute fuel and acted as a ceiling price to natural gas going into gas-turbine fired electric generation markets.

While noting that it was "very hard to be analytical and unemotional" in analyzing the energy market at this time, analyst Curt Launer of Credit Suisse Equity Research said he did not see as favorable an outlook for natural gas and electric prices. Given that 30% of domestic gas demand is industrial and about 20% of U.S. power demand is economically sensitive, "we expect natural gas and power prices to fall with an outlook of lower economic activity, absent a sustained oil price increase," he wrote in a "weekly analysis" report last week.

Launer agreed, however, that there would be a "renewed emphasis" on domestic energy sources and reducing U.S. reliance on imported oil. In 2000 the United States imported 11.4 million b/d of the 19.5 million b/d of oil consumed in this country. "We believe that a valuable reference point for the energy debate" in Congress is President Bush's National Energy Policy. "With a crisis of the current proportion before us, a review of the NEP with its plans to build U.S. infrastructure for power, natural gas, coal and nuclear fuels is likely to receive much attention," he said.

On the regulatory front, "we expect a more constructive and conciliatory FERC to contribute to the ability of the industry to raise capital to build what is needed," Launer noted. He acknowledged that Credit Suisse's concerns about the Commission prior to the Sept. 11 assaults now "seem very trivial and very far away."

UBS Warburg forecasts that the crisis could boost the demand for natural gas in the long term, and potentially lessen the controversy on Capitol Hill about opening ANWR to oil and gas drilling.

In a related development, some environmental groups have decided to refrain from publicly criticizing Bush's energy policy in the wake of the deadly terrorist attacks in Pennsylvania, New York City and near Washington DC. "I think that a lot of environmental groups feel the same. This is not the time for criticism. It's time to rally around President Bush" and his administration as they "respond to the perpetrators of this heinous act," said Elliott Negin, a spokesman for the Natural Resources Defense Council (NRDC) in Washington.

The NRDC is headquartered in New York City and has offices in Washington. Some of the group's employees "could see the plane going into the Pentagon" on Sept. 11, he noted. NRDC employees also "had friends or relatives killed" in the attack on the World Trade Center in New York, or know people who have friends or relatives who are missing, Negin said.

The NRDC will keep the gloves on with respect to energy until the Senate takes it up again, he said. "That's when it will be time to address the issue," Negin told NGI.

The Sierra Club, which has been extremely critical of Bush's energy initiatives, also pulled back somewhat, a spokeswoman for the group said. "That was true of last week," but "that's not a long term policy," she noted. "Once the [energy] debate re-surfaces, we'll be as engaged as anyone else."

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