One can't necessarily call it a sea change, but market sentiment toward the energy sector is definitely becoming more sanguine- whether that's in the equity or the commodities-trading arenas. And as this shift continues, particularly in the equity markets, investors may start discovering overlooked sector-value opportunities. These are some of the recent observations of an energy seer for Amaranth Advisors LLC, a Greenwich, Connecticut-based multi-strategy hedge-fund manager with assets under management of nearly $7 billion. These assets include investments in publicly traded equities, commodities and private debt or equity participations. "We see a lot of opportunity in the energy space, to which we currently have a 10% to 15% exposure," says Harry Arora, an Amaranth portfolio manager and a value investor with a focus on industry-wide fundamentals in the energy space. "Looking at publicly traded energy stocks, for instance, a lot of their recent valuations are based on $30 oil and sub-$5 gas pricing. However, we believe the market is gradually coming to the conclusion that over the next 12 to 36 months, this is much too low a pricing assumption." Arora has noticed this rethinking in the futures market, where the backwardation curve (which reflects lower pricing for a commodity many months or years out versus the nearer delivery months) has narrowed considerably. "Recently, the price of crude for 2006 delivery has been averaging in the mid-$50s, and for 2007, around $52." What all this suggests is that the investment community is getting used to the fact that there may be some creep in the long-run value of oil and gas, which over time should get factored into equity valuations, he contends. "With insufficient production available to cover current and projected demand, we have confidence in a strong commodity-price cycle over the next two- to four years. During that time, various energy sectors will have high profitability, some more so than others." The best stock values? Arora notes that the issues of offshore drillers have already enjoyed a huge run-up in value based on strengthening dayrates and increased margins. "On the other hand, the stocks of most E&P companies currently aren't reflecting anywhere near the level of profitability those producers could generate during the next couple of years." Similarly, he says, the stocks of land drillers generally aren't getting credit from the market for that sector's significant improvement in dayrates, margins and high utilization levels-nearly 100% in some cases. "In addition, while the stocks of pure refiners have drawn a lot of investor attention during the past 18 months-in recognition of very tight refining capacity and the fact that refining margins are significantly on the rise-the market hasn't accorded the same respect to integrated companies," Arora asserts. "Although integrateds have a lot of upstream exposure, they nonetheless have major downstream operations which are being overlooked. The market doesn't seem to be focused on the fact that integrateds control 75% of all refining capacity."

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