Morningstar Advisor - Fall 2008 - 70

We’re looking for companies that have well-placed assets. More specifically, we’re looking for companies that are in lowcost producing areas with room to grow. Eric Chenoweth, Associate Director, Morningstar energy equity analysis team EC: Companies with a lot of resource potential (so plenty of new gas supply to bring on at higher prices in the future) and a fair amount of debt (to better lever up equity returns) would fit this bill. We have a number of these, but my favorites include Quicksilver KWK, Southwestern Energy Company SWN, Range Resources Corporation RRC, and XTO Energy XTO. Watch List: North American Natural-Gas Firms Company Morningstar Rating Fair Value Estimate Fair Value Uncertainty Consider Buying Consider Selling PJ: What would keep you up at night? EC: My concerns are mostly on the supply side. Specifically, if the Haynesville shale turns out to have more than 10 years worth of U.S. natural-gas supply in the ground in a few counties in Louisiana (like one industry participant has suggested) and we can develop it easily and get the gas out more easily than I expect. That could suppress prices industrywide and drive down profitability. PJ: Would you buy a large basket of these names or focus on a few stocks in particular? EC: Since I am not aware of an ETF that focuses solely on U.S. natural gas equities, I would remain a stock-picker. However, investors seeking broader exposure to U.S. oil and natural-gas stocks could consider iShares Dow Jones US Oil and Gas Exploration IEO. Roughly half of the fortunes of the constituent stocks will depend on natural-gas production. An even broader domestic energy play would be iShares Dow Jones US Energy IYE, but its exposure to oil majors and refiners really dilutes the impact of natural gas. For investors speculating with high conviction that oil and gas prices will indeed be higher, which is a bet I will refrain from endorsing, you would likely want the leverage that comes with owning oil- and gas-services stocks. One way to gain exposure there would be the SPDR S&P Oil & Gas Equipment & Services XES. K Paul Justice, CFA, is an ETF strategist for Morningstar and contributing editor for Morningstar’s ETFInvestor newsletter. Apache APA EOG Resources EOG Quicksilver KWK Range Resources Corp. RRC Southwestern Energy SWN Ultra Petroleum UPL XTO Energy XTO Data as of Oct. 7, 2008 QQQQQ QQQQQ QQQQQ QQQQQ QQQQQ QQQQQ QQQQQ $182 $154 $48 $92 $64 $94 $89 Medium Medium V. High High High High High $136.50 $115.50 $26.40 $59.80 $41.60 $61.10 $57.90 $236.60 $200.20 $86.40 $138.00 $96.00 $141.00 $133.50 Watch List: Energy ETFs Company Valuation Rating Fair Value Estimate Expected Return Consider Buying Consider Selling iShares Dow Jones US Energy IYE SPDR S&P Oil & Gas Equipment & Services XES iShares Dow Jones US Oil & Gas Exploration IEO Data as of Oct. 7, 2008 Undervalued Undervalued Undervalued $57.08 $43.39 $88.65 32.5% 31.9% 39.6% $45.07 $36.54 $74.38 $68.73 $49.00 $99.76 generation fuel. So oil and gas don’t compete as directly as they do overseas. For example, in China natural gas and diesel (a refined product of crude oil) compete directly to generate electricity. Where they are direct competitors they tend to trade more closely. PJ: What else should we be looking at besides good equity returns as they boost their reserves and production per share. PJ: Which firms will likely hold up best if prices fall? EC: Companies with well-placed assets, plus companies with less debt would fit in this category. Ultra Petroleum UPL, Apache APA, and EOG Resources EOG are at the front of mind in this category. PJ: Which will benefit the most from another rally? commodity prices? EC: We’re looking for companies that have well-placed assets. More specifically, we’re looking for companies that are in low-cost producing areas with room to grow. These companies have the best chance of providing 70 Morningstar Advisor Fall 2008

Morningstar Advisor - Fall 2008

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