Institutional investors remain cautious about the energy space, but independent producers and at least one investment-banking firm are steadfastly bullish in their energy outlooks for 2007 and beyond.

This was the mood exhibited at the Raymond James & Associates energy conference in Orlando, Florida, where 50 energy companies presented to buysiders in early March.

"There appears to be a sharp disconnect between what we believe to be strong, long-term industry fundamentals and investor perception," says J. Marshall Adkins, director of equity research for Raymond James in Houston.

Clearly, there is some buysider concern about the direction of the global economy, he notes. Second, there is uncertainty about the natural gas environment beyond 2007, as storage has crept to a high absolute level relative to historical averages. "This, combined with the upcoming year-over-year summer-weather comparables, has contributed to the perception that summer 2007 ending inventories could be above the norm of 3.2 trillion cubic feet (Tcf)."

Third, a lot of momentum investors that were along for the bull ride in 2003-05 are scared about the traditional cyclicality in the energy space, observes Adkins. Lastly, with power in Congress changing hands, buysiders see a newfound degree of potential political risk.
"The view [of institutional investors] is that the Democratic Party is dead set on attacking energy companies, which have reported record profits, and that legislation for windfall taxes may be on the horizon."

Conversely, E&P presenters at the conference-focusing on the long-term supply/demand fundamentals of the industry-are optimistic about a commodity-price upturn in the next 12 months.

"As a group, producers believe natural gas has hit a floor at roughly $7, which makes for very favorable economics-especially since gas prices were as low as $1 to $2 just four years ago. Bottom line: the overwhelming sentiment [by operators] is that the E&P sector is going and growing."

Similarly, oil-service presenters indicated they see some stabilization in demand as the result of greater visibility on winter-ending gas-storage levels, which many thought last November could be as high as 1.8 to 1.9 Tcf, rather than the 1.4 Tcf that is projected now.

In addition, the service industry is showing discipline with respect to capacity additions, says Adkins. Specifically, most drilling contractors have either canceled or modified any new-build or refurbishment rig programs.

"Many management teams highlighted that the cost to buy or build a rig is so high that returns are more favorable with stock-buyback programs."

With a 2008 commodity-price forecast of $10 gas and $70 oil, Raymond James itself shares much of the industry's optimism and believes the pending supply problems facing the industry, such as decline rates and reduced productivity per well, are being drastically underestimated on Wall Street. Indeed, the firm believes the recent moderation in gas-drilling activity will likely result in a reduced supply response in late 2007.

The market-maker also foresees a very tight supply picture for oil in 2007 and 2008, even after factoring in a global economic slowdown. Why? It has lower-than-consensus expectations for non-OPEC supply growth during the coming years.

The investment banker also sees another industry trend afoot: E&P companies continuing to spin off their mature producing assets into master limited partnerships (MLPs). Adkins points out that MLPs are trading at 8.0 to 12 times 2007 EBITDA (earnings before interest, taxes, depreciation and amortization). Comparatively, E&P companies themselves are trading at almost a 50% discount to this, at 4.0 to 6.0 times 2007 EBITDA.

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