Oil and Gas Q&A (Drip Port) January 14, 1999

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Oil and Gas Q&A
Questions to consider before investing

by Brian Graney ([email protected])

Alexandria, VA (Jan. 14, 1999) -- We've learned a lot about the oil and gas industry in general over the past two months (yes, it's been two months since we started this thing!) A good deal of our qualitative analysis of the sector has been completed, leaving us with the quantitative analysis of individual companies to tackle in the days ahead. After a few final columns on the downstream end of the business next week, Jeff and I will move into the company-by-company analysis everyone has been waiting for.

Woo-hoo!

But first, let's reflect on what we've learned. Before making an investment decision in this industry, we've discovered that we first must come to some conclusions about the future of the sector as a whole. Here's a quick run-down of some of the major issues we've addressed in our columns so far (with appropriate links), followed by a quick peek at the opinions Jeff and I have developed regarding these various topics:

1.) What will the industry look like in 20 years? We've identified a few trends in the oil and gas sector that we believe must be factored into our investment decision. First, the industry will continue to consolidate as companies big and small look for ways to cut costs during the current low oil and gas price environment. The major integrated players have an added incentive to consolidate as the international business becomes more competitive and the mammoth, low-cost state-owned producers exert more of their influence in the years ahead. We expect more mergers will occur during the next twenty years, which will lead to higher overall profitability for the leaner and meaner companies and the emergence of a few clear-cut industry leaders.

2.) What is the outlook for supply? We feel quite certain that there is enough oil and gas in the ground to get us through our 20 year investment period. New technologies will help bring more oil and gas out from its geological hiding places around the globe, and new ways will be discovered to more efficiently process and market oil-derived fuels in the future. Foreign markets will remain important sources of oil and gas for producers, with the Middle East looming large in issues relating to supply. Untapped reserves in other regions around the world and in the deep water of the oceans will limit OPEC's influence over global supply in the years ahead, but the oil cartel will still hold considerable sway in the world's markets.

3.) What is the outlook for demand? Another trend that we have determined is that the world is going to need more energy in the future as new countries industrialize and others look to maintain their internal growth rates. This increased dependency will allow for more demand-side shocks in the future as emerging regions grow in fits and spurts. For companies closely tied to oil rather than natural gas, the ability to adjust quickly when demand changes for the better or for the worse will be a crucial determinant of long-term performance.

4.) What is the outlook for oil and gas prices? We have no control over oil and gas prices, and neither do the companies in the industry. This is a commodity business, so the players that can best react to fluctuations in the market price of oil and gas will win out over time. Ideally, we want to put our money with the company that is the leader when prices are high and when prices are low. Currently, we don't think oil and gas prices are at an equilibrium and we expect them to rise at some point in the future. We do not, however, want to be too pre-occupied by commodity prices throughout the life of our investment. We want smoothness in earnings over time regardless of the flux in the commodity markets, if possible.

5.) Where will the most growth occur? We've also learned that oil is not the end-all, be-all energy product of the future. It will certainly still be vital to the world's industrial and economic growth in the decades to come, but natural gas is taking on a greater importance in providing the world with its energy needs. From an investment standpoint, natural gas has certain benefits over oil -- benefits that may lead to higher future growth prospects for companies with a solid exposure to gas.

6.) What types of companies have an economic edge within the industry? The industry overall has been profitable in the past and we believe it will continue to be so in the future. Technology is a major issue and will be critical to the ultimate success of any energy company, whether it operates in the upstream end of the business or in the downstream. Among oil and gas exploration and production (E&P) companies, we believe the major integrated firms may have certain economic advantages over their smaller, less-diversified peers, allowing them to retain higher relative levels of profitability in good times and bad. Next week, we will determine if this trait is consistent in downstream companies as well.

With these conclusions in mind, Jeff and I feel prepared to look at our list of oil and gas Drip candidates and figure out just who is top dog in what has become a share price junkyard over the last year or so. For those Fools following along at home, don't blindly accept what Jeff and I think is going to happen over the next 20 years in this industry. Come to your own conclusions for the above questions before placing your first dime in an oil and gas-related Drip. When you do, share your thoughts with us and other Fools on the Drip Companies message board.

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