Wall Street analysts expect independents' exceptionally strong second-quarter performances to continue through year-end, finally making the sector more attractive to investors. "I think they're starting to come around," observes Brad Davis of Southwest Securities in Houston. "Investors got burned so bad in the late 1997-98 time frame that they've taken a real show-me attitude. One of the things they're looking for is a return to profitability. They don't want just one quarter. They want to see it in several quarters. So I think if commodity prices remain strong going into the first part of 2001-and I absolutely believe they will-I think Wall Street will come back to E&P stocks." "It looks to me like the group is really poised to move," says Greg McMichael of A.G. Edwards & Sons in Denver. "I think earnings in the second quarter will be a partial catalyst. Others will be the fact that oil and gas prices seem to have stabilized and are not going down at this point, and that the Nasdaq is starting to get choppy again." The second-quarter performance by independents has been phenomenal. Sixteen selected producers showed obvious and dramatic overall profitability improvement, when comparing their second-quarter operating income and revenues with that of second-quarter 1999. The group's total operating income jumped 345.8% on revenues that climbed 67.7%. For many, especially those weighted to gas, the good times should keep on coming. "I don't think we've hit the peak. I think [high earnings] will continue in the third quarter," says McMichael. "They will also continue in the fourth quarter, but I think that will probably be the peak." Stephen Smith of Dain Rauscher Wessels in Houston says, "Gas prices could be better in the second half-certainly it'll match [the first half]-and crude prices will probably come down. So whether or not it was a record quarter would depend on your oil and gas mix. I don't think it will be terribly worse in the third quarter than it was in the second quarter for the average company. In fact, if you're gassy it could be better." What's more, an increasing number of companies will be better equipped to enjoy strong commodity prices as their hedges expire during the coming months. While hedging can be a useful balance-sheet tool, some companies have been unable to reap the benefits of soaring commodity prices this year. "In the fourth quarter, most of the companies we look at are largely unhedged," says McMichael. So what are independents that are flush with cash going to do now? Strengthening their balance sheets will remain a priority, as it was in 1999. But some are beginning to open their pockets a bit wider to fund some exploration and development projects. Prices would have to take a pretty sharp turn south before companies begin to rein in spending, Davis says. "This is a business of reinvestment. I think that to get back down to where it's not feasible to reinvest, you've got to go below $20 [per barrel of oil] and you've got to go below $2 [per thousand cubic feet] on natural gas. So I think companies are going to continue to do well in the near term." -Jodi Wetuski

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