It was good to be in energy stocks in 2004. "Upstream, downstream, oil service or coal, take your pick: shareholder returns were delightful," report John S. Herold Inc. analysts Bob Gillon and Kathryn Berger in the firm's annual year-end shareholder-returns review. The analysis of 360 energy companies' 2004 shareholder returns-stock-price performance plus dividends or distributions-turned up improved results for nearly 90% of the companies reviewed and 48 produced double that of 2003, which was also a strong year for the energy sector. "The best returns came from companies operating outside of North America, not just in the E&P sector, but also in coal production and refining," the analysts report. It was good, but not as good, to be in major-oil stocks. "Mass appeared to detract from performance again this year. The giant oils continue to lag behind other integrateds that lack exposure to the North American downstream." The group's average return was 24.5%. Meanwhile, "all categories of independents provided superior returns to the group we categorize as super-independents, those with internationally diversified reserves and production." The super-independents-13 of them and including EnCana Corp. and Devon Energy-had an average return of 36.6% while large U.S. independents (10, including Noble Energy and XTO Energy) produced 45.3%; midsize independents (13, including Denbury Resources and Whiting Petroleum), 64.4%; and small independents (48, including Delta Petroleum and Brigham Exploration), 38.9%. Nearly all 81 independents that were reviewed produced returns in 2004-"In aggregate, the group appreciated by $79 billion, or 19% more than in 2003"-except for a handful of small producers, including McMoRan Exploration, NGas Resources and Heartland Oil & Gas, in part due to fiscal-profile shape-shifting and other maladies. "While it is no surprise that E&Ps had another great year, the continuing performance disadvantage of U.S. producers relative to other operating regions should be noted," Gillon and Berger add. "Drilling successes have led to wealth creation that is hard to duplicate in mature regions." In the battle for prominence among ExxonMobil, BP and Shell, "ExxonMobil made up the ground it lost to BP Plc last year, and both continued to outperform Royal Dutch/Shell." ExxonMobil produced a 27.6% total return; BP, 21.8%; and Shell, 17.9%. For a third consecutive year, "companies with assets outside of North America turned in the top returns." Examples are Maurel et Prom, which operates in Congo; Cairn Energy, which had a large oil discovery in India; and Tullow Oil, whose "timely purchase" of Energy Africa in 2004 gave it a piece of Maurel et Prom's success in Africa. Gillon and Berger made special note of XTO Energy's returns, which ranked among the top of its large-independent-group peers a fifth consecutive year, and Canadian Natural Resources, which has done so in its super-independent group the past four years. Industry consolidation continued in 2004 with 22 companies in the 2003 survey absorbed by mergers-five more than in 2002. "While a 30% pickup in deal count is substantial, the average was 28 annually for the prior six years, so 2004 can't be seen as active by any stretch of the imagination," they said. The largest corporate transaction of the past two years in the study group was the 2004 purchase of Westport Resources by Kerr-McGee Corp. In Canada in 2004, 22 companies fell out-10 of them were purchased, mostly midsize producers taken up by royalty trusts, Rio Alto Resources liquidated and Ultima Energy merged with a larger trust, "the first sign the group has resorted to cannibalism," the report said. To supplement the 2004 study group, the analysts added coal producers. "We started this survey at the end of 1996 with 300 companies and have lost 205 of them to mergers, or worse fates-there are a few the regulators won't let you trade anymore." It turned out that the newly added coal-producer group had the strongest shareholder returns in 2004 among all the energy-sector groups reviewed. "We think developments in the international coal market may alert us to trends in world natural gas prices." The Herold report is replete with unique observations-the kind studious analysts make after long hours of poring over names and numbers. In this year's review, Gillon and Berger found that "C" and "P" are the most common first letters in the names of companies that have been acquired, "a whopping 24 times each." The characters start 8% of studied-company names and represent more than 23% of the takeover bids. "One might quibble, saying that P should be common, what with so many companies having Petro at the start of the title. But what of C, and why does it merge six times as often as D? And what might this portend for Chesapeake Energy and cross-town neighbor Devon Energy?" The analysts are more confident in whether continued strong energy-company shareholder returns can be sustained. "Yes, we know we said that last year. We note that the Nymex forward curves predict small gains in prices next year, about 3% for oil and 8% for natural gas. If that proves to be the case, and Nymex has been no better or worse than other forecasters, gains in revenue will be more than offset by higher costs." Besides rising finding and development costs, as well as acquisition costs, the analysts say a key factor to watch in 2005 is the U.S. dollar's strength. "Although we cannot quantify the impact, the reduced demand for U.S. equities is propping up the returns on other markets." The Herold analysts converted all company data to U.S. dollars in their study of 2004 results. "For residents of nearly every other country, returns have been lower than the figures we mention. Total SA, for example, closed the year within pennies of its all-time high in New York trading, but in Paris, where it is priced in euros, the stock was down by more than 15% from the peak set in the second half of 2000." The analysts conclude from the overall 2004 results, "The rising tide continues to float all boats; we'll find out which ones have leaks one of these years." -Nissa Darbonne

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