March blew in like a lion off the Massachusetts Bay to greet winter-weary commuters hustling out of South Station into Boston's financial district, home to many of the nation's largest mutual funds. Sitting comfortably 31 floors above the crowds, one of that industry's best-known public-equity energy investors spoke confidently about the global economy, energy markets, investment strategy, drilling and completion methods, wellhead economics, matrix porosity—you name it.

"I could spend all day talking about this stuff," Dan Rice says. He can't, however, because an E&P management team is waiting in the lobby to present its plans.

Rice is a managing director of BlackRock Inc., overseeing its $1.1-billion Energy & Resources Fund. With more than seven dozen energy-related businesses in his portfolio, Rice is a must-see for any company road show, not to mention a vote of confidence if he submits a buy order. Rice discussed his investment views in early March.

Macro view

First, he uses a macroeconomic approach. "We get the commodity-price forecast right, and then we focus on the stocks," says Rice. "Everything interacts with everything else. So, for example, a coal strike in China impacts natural gas prices in Appalachia."

Individual stocks take the back seat during this dialogue, as Rice's macro view emerges as the dominant investment theme. Global oil-production growth cannot keep pace with 3% or greater global gross domestic product growth, as evidenced by the 2008 price spike and subsequent economic bust, he points out. The world is simply too commodity short at this growth level or above.

Somewhere below the 3% range, commodities production may keep pace with the attendant demand, but not above. Of course, the fact that global GDP growth has resumed, and may exceed this level again, leads Rice to a logical prediction: another commodity-induced recession before year-end 2012, throttling global GDP growth back to a serviceable 2% range.

Rice expects oil to appreciate at the inflation rate from a $90-per-barrel baseline, subject to global GDP variations and an array of government policy choices. "Quantitative easing by the Fed takes the lid off of demand and contributes to commodity-price increases," he says.

Meanwhile, China could contain inflation by allowing its currency to appreciate. And the upheaval in the Middle East? Rice dismisses this phenomenon as incremental, maybe adding $10 per barrel or so.

By taking a macro approach, Rice avoids the need for 10 bottom-up stock pickers. He runs the fund with just one other person.

The fund does use three dozen consultants for specialized expertise. "We had a guy in China a few years ago counting coal cars on train tracks and clocking their travel speeds." This bottom-up macro analysis tipped off BlackRock that coal rail freights had reached a limit. The resulting increased truck usage for coal shipments within China led to rising diesel demand, and eventually, to the conversion of a major highway to one-way overnight traffic to facilitate coal deliveries to meet that demand.

Coal companies comprise no fewer than five of Rice's top 10 equity holdings, with Massey Energy, Peabody Energy and Consol Energy representing the top three concentrations, or nearly 15% of the fund at year-end. These have been long-term holds, contributing to superior capital appreciation as the fund beat the Lipper Global Natural Resources Fund Average by 1.8:1 in 2010, and by 1.3:1 over the past decade. Rice's top-down view supported these stock picks before, during and after the 2008 economic decline.

"We had a guy in China a few years ago counting coal cars on train tracks and clocking their travel speeds." Dan Rice, BlackRock Inc.

Two to three of the fund's consultants are Chinese experts. A couple of others specialize in European market conditions and another focuses on the Former Soviet Union. All this support drives the macro approach and an informed view on government policy.

In fact, Rice surmises that misguided government policy may become an election issue next year. "The Obama administration was given the gift of shale gas," he says. And yet the administration embraces wind energy and solar energy—decades-old technologies—and eschews shale gas, the new cutting-edge supply that delivers energy at one-half to one-third the cost. There was never a solution for gasoline price spikes in the past, he notes, but now there is, because of abundant natural gas.

Gas at what price?

But what about all that natural gas? Is shale gas really a panacea?

Any discussion of natural gas must include a view on the clearing price for natural gas in any given play. "The Marcellus shale is the most attractive gas shale play, by far," says Rice. The wellhead economics of some other gas shales have suffered, as the gas price has fallen and companies engage in held-by-production (HBP) drilling, adding further to supplies.

But Rice predicts that HBP drilling will dwindle in the third quarter of 2011, as independents migrate rigs to oil shales. He guesses that $5 to $5.50 per thousand cubic feet (Mcf) may be needed to earn a sufficient return from much of the gas shale drilling, but he also guesses that independents may be loath to return to some gas shale plays until prices reach at least $6.50 to $7.

"It's an easy decision," he says, noting that a company can earn a 60% field level internal rate of return (IRR) drilling oil shales, or a 15% IRR drilling gas shales.

Many stocks still discount higher gas prices, Rice notes, further compounding the challenge of buying or owning certain natural gas-focused independents. He has thought about buying long-dated options on one company that could be worth 150% more at $7 per Mcf than it is today, but hasn't yet acted on this idea.

The Marcellus shale remains attractive to Rice despite the unending gas-price slump, and his holdings of Range Resources, Consol Energy and EQT reflect this view. He notes that the vast industry experience accumulated in the Barnett shale excessively influenced early Marcellus drilling and completion methods, leading to mixed results and lower estimated ultimate recoveries (EURs).

Non-Barnett players stumbling into the Marcellus with their own learning curve have achieved significant improvements in recoverable reserves per well, however, and this knowledge has spread throughout the play. The effect? What once were 4-Bcf (billion cubic feet) wells are now being drilled and completed with EURs of 8 to 10 Bcf in the better areas.

With increasing recoveries comes increased density drilling. This leads Rice to favor certain dominant Marcellus players that the market may be undervaluing, because this learning curve has not yet manifested itself in reported reserve growth. Chevron, he observes, has to know that it got a better deal buying Atlas Energy Inc. than it initially thought.

Liquid and cheap

The conversation drifts toward other aspects of BlackRock's investment portfolio. The fund owns some unlisted companies, which is somewhat unusual. "Ninety-two percent of the portfolio can be sold in two days," he says. Another 4% may take a little longer, for companies with less trading volume. As for the remaining 4% that are even less liquid, BlackRock's plan would be to sit on them until they are sold.

Just over 12% of the portfolio consists of metals and mining companies, and less than 6% is made up of oilfield service and supply companies. He has historically bought service companies, but the portfolio is currently concentrated in coal and independent natural gas companies. That's where he has identified better values, and where he expects takeovers and consolidation. "It has to happen."

The macro approach eclipses any emphasis on building geographic diversification in the portfolio. Rice says he simply goes to the cheapest place, where there is value not reflected in stock prices—the U.S. and Canada.

Where will the next significant, scalable play emerge? The southern Alberta Basin Bakken is one possibility, as is the Monterey shale or the Niobrara. But Rice cautions that matrix porosity in these plays remains a concern. Investment opportunities exist with companies engaged in commercial development where this risk is absent.

Rice is not a trader. Instead, he is a long-term investor. The more volatility there is, the less one should trade, he says, though in another breath he mentions a company whose shares he recently pared down due to his disappointment with management's recent capital-allocation decisions.

What about master limited partnerships and royalty trusts? These don't much interest Rice, because a component of quarterly distributions includes a return of capital, and market values seem high relative to the underlying assets and limits to growth. Even pipeline companies have to reinvest in fixed assets, he notes, so not all their distributions are true earnings. And besides, he is in it for the growth.

Time is up and Rice's next meeting begins—face time with that E&P management team hoping to produce oil from shale in Montana. In a commodity-short world, with global GDP galloping past 3% growth, that's probably a meeting worth taking.

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