Smaller companies to the fore as investors watch 'energy play'

For people looking to invest in energy in the last several years, big oil companies have been an obvious choice. But for the longer term, there may be greater opportunities with the small, independent, and largely unknown oil and gas companies.

There are plenty to pick from. William Tichy, an analyst with Dean Witter Reynolds in San Francisco, estimates that about 10,000 of them are scattered around the United States, half the number that were in business in the early 1950s.

Discovering these small operators is oly part of the problem. A more difficult task is culling through the list and selecting those with basically sound reasons for investment consideration.

As Wall Street begins taking notice of the stronger survivors among the small oil and gas companies, the Eurobond market, not usually a source of venture capital, is showing an interest in some of these operators, primarily those involved in drilling and prospecting for oil in the US. Several convertible Eurobond issues were successfully floated for small oil companies, some of them having comparatively little equity capital and only a sparse performance record.

Investors should be aware that with this group, earnings are not a critical factor or important measure of assessment. The quality of management, the drilling exposure, and the accounting used may be more significant. The risks may be too high for some to qualify them as investments, but Mr. Tichy notes that "in that context there still are some very, very good opportunities."

Whether the prices on many of these independents have run up too far too fast is a "relative question," he contends. "Between 1975 and '77 a lot of these companies were relatively undiscovered on Wall Street. The Street really wasn't tuned into them, whether it was a Mitchell Energy, a Noble Affiliates, or an Amarex. When institutions thought of oil and gas, what primarily came to mind were the Shells, Exxons, and Mobils."

Now, however, there's "much, much more" institutional interest, bringing new respectability to a group that has seen the fortunes of many small oil and gas companies go from rags to riches since the late 1950s. Mr. Tichy says the "rags" period was 1958-73, when many operators simply folded because of depressed product prices and a domestic drilling slump.

Those that managed to hang on and survive, though, did well in the latter half of the 1970s. "The 1980s should prove to be a rewarding period as well, despite the advent of increased controls and legislation from Washington," Mr. Tichy says.

Entrepreneurs who started and ran many of what he calls the "pure" independent oil and gas operations are a "tough breed," pretty well equipped to deal and live with the Natural Gas Policy Act and the windfall-profits tax.

"The net result of most of this legislation is that operators will have to hire more accountants and attorneys to interpret the rules of the game, and costs will ultimately be passed along to the consumer," Mr. Tichy predicts.

With rising product prices and higher profits by the independents, there will probably continue to be high levels of acquisitions, tenders, and other forms of industry consolidation in the decade ahead. The oil and gas industry isn't very labor-intensive but it is extremely capital-intensive, he points out.

"The high cost of money, coupled with the fact drilling costs are rising at a 20 to 30 percent annual rate, could result in more operators cashing in," he says, selling out to bigger companies, not necessarily only those directly involved in energy -- railroads and forest products companies, for example.

Small and medium-size oil and gas operators with a decent base of reserves, good cash flow, an access to capital, and a promising inventory of undeveloped leases "should be in excellent position to recod well-above-average growth in the 1980s," the analyst says.

He's particularly high on producers such as Adobe Oil & Gas, Amarex, Bow Valley Industries, mitchell Energy & Development, and Natomas Company.

As a corollary to his positive outlook for the independent oil and gas producers over the coming 10 years, Mr. Tichy also favors suppliers of equipment and services to the oil and gas industry, which he says will see a "healthy" growth rate in the 1980s.

Estimates are that in 1990 there may be 4,500 rigs active in the US, with 80, 000 or more wells drilled that year. Total footage drilled should rise from last year's 250 million feet to 360 million feet per year by the end of the 1980 s. He envisions "good growth opportunities" for Parker Drilling, Varco International, and Weatherford International.

Much of the push behind the continued consolidation of the small oil and gas companies that survived the shakeout during the "rags" phase from 1958 to 1973 comes from major oil companies.

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