Moves by savvy energy investors could mean oil stocks on the rebound

Don Stowers
Editor-OGFJ

Lately there has been some encouraging news that smart money is moving back into energy, although these investments tend to be cautious. At the same time, we hear that earnings will be off sharply in the fourth quarter, and as a result, oil and gas companies will be running leaner after the wild ride they have enjoyed in the past year or so with high commodity prices.

The Wall Street Journal recently reported that Oklahoma billionaire George B. Kaiser, widely considered one of the country’s shrewdest energy investors, is moving his investments back into the petroleum industry. A veteran oilman, Kaiser is a founder of privately-held Kaiser-Francis Oil Co.

In one of two deals, Argonaut Private Equity, a private equity firm controlled by Kaiser, announced it is buying assets from Chesapeake Energy for $412 million in a transaction financed by Goldman Sachs. In the second transaction, Kaiser purchased $50 million of shares in another gas producer, Sand-Ridge Energy, from that company’s chairman and CEO, Tom Ward, formerly president and COO of Chesapeake before he cashed out and formed his own company in 2005. Both Chesapeake and Sand-Ridge are based in Oklahoma City.

Kaiser’s role in this is viewed by industry observers as important because of his reputation as a savvy investor who built Kaiser-Francis into one of the country’s largest private oil and gas producers in part by buying up assets during market downturns.

Back in November, Chesapeake closed on a joint venture in the Marcellus shale with Norway’s StatoilHydro. Chesapeake sold a 32.5% interest in its interests in Appalachia for about $3.4 billion. Chesapeake received a much-needed infusion of $1.25 billion in cash from StatoilHydro at closing and will get the remainder from 2009 through 2012. This was critical for Chesapeake, which needed the funds in order to aggressively pursue its drilling program and additional acquisitions, and StatoilHydro gains expertise in drilling and operating in shale formations and a large piece of the unconventional pie in North America.

Since the highs of mid-summer, oil companies have taken a beating as stock prices plummeted along with declining oil and natural gas prices. Some are still near their nadir, but others appear to be recovering somewhat. A key reason is that investors now believe that oil company stocks are about as low as they’re going to get.

Another prominent investor Kirk Kerkorian recently added nearly two million shares to his 40-million share holdings in Delta Petroleum Co., a Denver-based producer. Other investors have targeted companies like El Paso Corp., which is both a producer and a pipeline company.

Savvy investors are structuring the deals carefully to minimize risk. For example, Kaiser bought Sand-Ridge stock at $5.62 a share and retains the right to sell it back to Ward for the same price. In his deal with Chesapeake, Kaiser bought eight years of gas production from existing wells that are already producing, so he doesn’t have to worry about bearing the cost of dry holes.

So why is energy a smart investment? In part because it’s a finite resource. Whether or not you subscribe to the peak oil theory, global demand for hydrocarbons will continue to grow because the alternatives cannot possibly supply enough energy to meet the needs of a growing population. Over the long run, it will be a struggle to supply petroleum products to the ever-increasing demands of energy-hungry nations. This will drive prices back up.

During a presentation in late January before dozens of energy executives in Houston, Dr. Michael Economides of the University of Houston made his case for $100 oil by the end of 2009. He predicts oil will reach this level again due to demand-and-supply issues that will occur “regardless of whether or not the economy starts to recover.”

If Economides is right, many energy companies that are currently downsizing and suffering through lower oil and natural gas prices and their lowest level of earnings in five years will begin to recover quickly, especially if operational costs continue to decline.

As super majors and independents alike hunker down and cut costs until the economic storm passes, it is likely their market capitalization will suffer. As Kaiser and Kerkorian and Warren Buffet have taught us, there is never a better time to buy. Because as sure as the sun sets in the west, energy demand will return and companies that survive will be in a better position than ever.