Forecasting exploration and production companies’ stock price performance can be a real headache because it can’t be done by traditional means. According to a new Lehman Brother’s report, it turns out that the key determinants of large and small E&P company share price performance are per share growth in reserves, production and cash flow, rather than historical accounting measures, such as earnings and returns on capital.

Growth rates in cash flow, production and reserves per share offer investors a reliable mode to predict share prices with an R2 of 69% for the 1997-2000 period, Lehman Brothers analyst Thomas R. Driscoll said in his report “What Drives E&P Shares.” In contrast, both rate of return (ROE) and return on capital employed (ROCE) had an R2 of 3% when correlated with stock price performance. Other measures, specific to the oil and gas industry, such as efficiency rations, reserve replacement rates and finding and development costs, also offer very weak correlation to stock price appreciation.

Despite common beliefs that E&P stocks do well based on the companies’ ROE and ROCE, those historical measures actually show very little correlation with stock price performance because of distortions caused by the volatile commodity prices and the various accounting methods (full costs versus successful efforts and purchase versus pooling) used by the companies, Driscoll said.

Anadarko Petroleum and Canadian Natural Resources show the strongest annual growth rates among the large cap companies, while XTO Energy and Newfield Exploration delivered the strongest results among the mid to small cap companies. Anadarko had an average growth rate for reserves, production and cash flow of 22.3% over the 1997-2001 period and had a 12.8% stock price appreciation. XTO showed average growth of reserves, production and cash flow of 26% and its stock jumped 30.6%. In contrast, among the large caps Pioneer Natural showed a 6.9% average decline in reserves, production and cash flow and its shares fell 13.2%. And in the small caps, Nuevo Energy showed an average growth rate of only 0.4% and its stock fell 23.5% over the 1997-2001 period.

“Due to the asset-based nature of E&P companies, we have found that per share growth rates (for production, reserves and cash flow) are the most reliable predictors of stock price performance,” said Driscoll.

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