msa62097.pdf | Barrel (Unit) | Valuation (Finance)

MORGAN STANLEY DEAN WITTER

Equity Research North America

In-Depth

Page 1

Industry

Exploration & Production
Industry Overview

Lloyd Byrne (byrnel@ms.com) (212) 761-8343 Philip Kehl (kehlp@ms.com) (212) 761-3472

May 15, 2000

E&P Valuation Mosaic, An Industry Primer
• E&P Valuation Mosaic covers the fundamental basics . . .
In the following pages, Lloyd Byrne and Philip Kehl walk through the basics of the exploration and production group, addressing primary valuation metrics, accounting vagaries, emerging trends and close with our current investment perspective.

Please refer to important disclosures at the end of this report.

the investor needs to assess the inherent exploration option. We can then apply this information to annual production of the company (which we can derive from the reserve report and the reserve life) (see Exhibits 1 and 2). A company that consistently replaces production with low finding costs would most likely be successful regardless of commodity prices. We think it is best to look at many different valuation metrics in order to arrive at a range of value at which we would buy or sell a stock. With experience we know the characteristics of numerous fields and the production costs associated with each. addressing primary valuation metrics. We can use this information to estimate the value of a company (or stock). That company also would exhibit a high degree of capital discipline and score well on measures in which we believe highly. The SEC requires a calculation like this in the 10-K. however. If we view E&P stocks only as financial instruments. so this SECmandated calculation can be misleading. emerging trends and close with our current investment perspective. accounting vagaries. We can also ascertain any company’s production levels with a reasonable degree of accuracy. Net asset value provides a nice reality check for stock prices since it approximates private market value or liquidation value. Since the balance sheet shows only the original cost of leases or acquisitions. . As we learn the operating style of management. we have almost instant access to oil and gas prices worldwide. Setting the Stage: The oil and gas industry is a data-friendly environment. In the case of Devon Energy the value is approximately $53/share. like return on equity and return on capital. Similar metrics would be liquidation value or net present value. then E&P companies are best analyzed with a finely tuned oil and gas price forecast. Another way to calculate net asset value is to examine the prices paid in the recent past for reserves in the fields in which the company operates. Our calculated asset value can then be substituted for book assets in the balance sheet to arrive at an adjusted book value or net asset value. The Valuation Methods: One of the best commodity-based valuation metrics is net asset value. We also should study a reserve report and the company’s cost structure.MORGAN STANLEY DEAN WITTER Page 2 E&P Valuation Mosaic. Exploration & Production – May 15. A stock trading well below net asset value should probably be bought. The most important factor to consider is that E&P stocks are both commodity surrogates and financial instruments. Lloyd Byrne and Philip Kehl walk through the basics of the exploration and production group. while allowing for some degree of luck. These transaction values can then be applied to the reserves in question to arrive at an asset valuation. The costs of third party products and services can also be determined fairly accurately. and one selling well above net asset value should raise a red flag. As analysts. requires disclosure of reserve quantities (barrels of oil and cubic feet of gas). That said. If we wish to view them only as commodity surrogates. Which of these metrics is the most important? How can we use them to determine value? These are some of the questions we will try to answer in this introduction to our compilation of E&P statistics. Year-end oil and gas prices can be much higher or much lower than an analyst’s estimate of future prices. We can then apply a discount rate to the sum of this net future revenue to arrive at an approximation of value for the assets. The SEC. but this calculation is based on year-end prices held constant forever. To then determine whether the stock is a sale candidate. 2000 Please refer to important disclosures at the end of this report. there is one metric that seems to tie the commodity and financial world together — the finding cost or the cost of adding reserves. A starting point is to have a view of oil and gas prices (a price deck) and an estimate of the company’s production costs. book value (assets minus liabilities) is of little use in assessing the value of an E&P company. An Industry Primer In the following pages. then we should be most interested in returns on equity and returns on capital. we can estimate a company’s cost of adding reserves by including in our calculations an appraisal of management’s skill.

2 775.1 31.3 49.57 $141.4 469.0 5.17 3.7 355.7 435.1 73.5 451.1 Source: Company financials and MSDW Equity Research Estimates Exploration & Production – May 15.9 85.25 $527.6 66.75 Pricing Parameters: OIL 2000 $26.54 2.73 2.256.3 49.29 $128.296.00 Thereafter 3.3 246.1 89.26 20.5% ($0.22 $454.06 3.Discounted Cash Flow Reserve Valuation (Reserves as of December 31.7 435.5 466.6 359.29 Oil Revenues ($MM) $695.105.163.1 18.0 8490.65 $442.6 261. Cost Parameters: Production Costs Production Decline: Oil Natural Gas Reserves: Oil Natural Gas Shares Outstanding (MM): ($2.7 2013 30.4 295.3 21.9 461.09 17.3 360.0 440.4 81.1 77.23 $116.8 27.3 446.2 287.5 1.4 290.3 703.7 456.5 358.896.0 885.9 452.75 0.0 253.8%) Total Future Pre-Tax CF ($MM) $941.3 430.1 51.7 2003 261.037.5% Company Diff.30 26.5 Pricing $ / Mcf $2.0 583.09 17.91) GAS $2.53 23.2 0.9 222.01 $171.09 17. 1999) Reserves Year (MMBbls.7 23.3 49.50 $2.6 1.6 2002 291.0 440.67 22.60 $2.608.4 2.6 Total Development Costs ($MM) 49.9 199.2 69.3 $7.9 30.3 575.94 3.0 2010 87. .050.4 353. 2000 Please refer to important disclosures at the end of this report.9 2011 67.51 19.MORGAN STANLEY DEAN WITTER Page 3 Exhibit 1 Devon Energy .27 2.45 2.28 2.3 446.8 1.2 1.29 Reserves (Bcf) 1.04 20.) 2000 353.3 338.18 2.3 430.4 1.6 199.63 2.22) Net Present Value / Equivalent Bbl Reserves Net Debt / Equivalent Barrel Reserves E&P Allocated Net Debt Liquidation Stock Price $3.78 $520.1 353.57 711.2 13.3 311.000.53 $70.84 21.44 $95.18 2.09 17.4 Balance Total OIL Production (MMBbls.40 3.3 28.40 $611.92 $52.56 0.8 451.5 Gas Revenues ($MM) $687.2 356.00 2001 $20.2 808.8 281.7 361.36 2.42 24.69 $366.0 424.7 2005 205.0 1.1 NPV (9.4 2007 154.1 20.9 766.34 1.84 2.6 517.1 925.3 49.31 $105.4 646.8 2012 48.9 719.40 $2.4 2004 232.0 24.3 338.6 419.79 18.383.18 2.570.77 $734.2 1.896.4 2006 179.0 725.6 419.3 Total Revenues ($MM) $1.) 30.5 305.3 491.0 424.84 3% 3% 53% 47% 86.3 2009 109.1 17.77 544.38 2.09 17.34 25.1 19.00 2004 $20.3 614.5 Total Pre-Tax Cash Flow ($MM) 1034.00 2003 $20.00 2002 $20.4 22.6 2014 13.0 267.2 NATURAL GAS Production (Bcf) 288.17 $155.7 Pricing $ / Bbl 23.40 $2.7 2001 323.5 Total Production Costs ($MM) 300.2 275.062.2 1.3 26.1 321.7 2008 131.

Apache and Anadarko).1 $23.g. 2000 Please refer to important disclosures at the end of this report.14 1. In Full Cost accounting the entire cost of drilling a well or acquiring reserves is capitalized. each year) 2000 2001 2002 2003 2004 % of F&D for Dev.09 31.1 676. In Successful Efforts accounting.99 9.40 $2.91 -$2.8% 45% GAS $2.00 $20.3 $ 4. That is why most small companies use full cost accounting.40 3. Morgan Stanley Dean Witter Research Other Metrics Are Needed As Well: Asset values alone can be too subjective. Drilling costs are capitalized even if the well is unsuccessful.5 145.7 135.00 $20. It is easy to see that a small company using successful efforts accounting would be subject to wild fluctuations in earnings.5% -$2. financial reporting for oil and gas companies has been confusing since there are two different accounting methods used in the industry.0 Source: Company data. Fixed Differential Discount Rate Tax Rate Devon Energy-Combined 1999 Cost Parameters: Production Costs ($/Bbl) $ 3.3 $ 3.50 $2.2000 Production (Bcf) (2001) Pricing Parameters: 2000 2001 2002 2003 2004 Thereafter Company Diff.2000 Pricing ($/Bbl) .00 3.Input Page Company Name Latest Year Oil (2000) Total Reserves (MMBbls) Undeveloped Reserves (MMBbls) Production (MMbbls) . which may have contributed to the destruction of capital in the energy sector over the past ten years.84 353. Exploration & Production – May 15.2000 Pricing ($/Mcf) .1 288.569.0 30. the cost of unsuccessful drilling is expensed in the period the well is abandoned.3 $2. Interestingly.896.9 Development Costs (% dev.00 $20. Certain costs incurred in the course of exploration like seismic surveys are also expensed as they occur (Exhibit 3). many large companies that once were small still use full cost accounting (e.60 $2.2000 Production (MMBbls) (2001) Natural Gas (2000) Total Reserves (Bcf) Undeveloped Reserves (Bcf) Production (Bcf) .519.38 311. and since E&P stocks are also financial assets we can apply traditional financial analyses.00 $20.22 Historical F&D Costs Production Decline: Oil Natural Gas Reserves: Oil Natural Gas Shares Outstanding (MM): Net Debt Total Assets Total E&P Assets Oil / Gas Conversion: $ 3% 3% 53% 47% 86. Since E&P analysts didn’t focus on earnings.5% -$0. Historically.40 $2. .4 OIL $26. 20% 20% 20% 20% 20% 75% $6.MORGAN STANLEY DEAN WITTER Page 4 Exhibit 2 Reserve Valuation .3 6. company management didn’t focus on earnings either..

but also its non-cash costs (which are the costs of leases and reserves acquired in the past).0% 1994 1995 1996 1997 1998 Source: Stern Stewart. taxes. and are attempting to become more disciplined in their capital investments.0% -4. A dollar spent on the business should be recovered through operations whether it is capitalized or expensed. we have graphed significant historic trading metrics including EV/EBITDAX. but they are not necessarily “cheaper” stocks.MORGAN STANLEY DEAN WITTER Page 5 Exhibit 3 Full Cost vs. 1993 -2. We find this an increasingly useful metric since many producers have a high degree of financial leverage.WACC We believe most E&P companies have recognized this failure.0% -10. depreciation. and it should exceed the cost of that capital. which is the reason capital has stopped flowing into the segment (Exhibit 4).e. cash flow was the metric of choice for valuation. . Combining Metrics: The discussion of capital discipline leads us back to square one: a meeting of commodity-based metrics and financial metrics. it all comes back to earnings. It is the earnings thrown off by the capital employed in the business.0% Equal Weighted SEVA. We also like to see a return on capital employed (ROCE) that exceeds the cost of capital. however. Enterprise value (EV) is the sum of equity market capitalization and debt. ROCE is a refinement of EV/EBITDAX. ROCE Has Lagged WACC 2. A renewed emphasis on positive earnings is going a long way toward instilling capital discipline in the industry (see our piece “To E&P or Not to Be. Are investors getting a return on capital.0% -8. 1999) Historically. This metric essentially compares the capital invested in the company to cash flow before interest and taxes.0% -12. EBITDAX is earnings before interest. Morgan Stanley Dean Witter Research We think that earnings do matter. The problem with using cash flow as a valuation metric is that it tells you nothing about rate of return on investment. In the end. Positive earnings show that a company is covering not only its cash costs. It compares income after tax but before interest to the sum of debt plus equity. In our opinion.” dated December 13. Both cash and noncash (i. Their capital budgets have recently been limited to cash flow since external financing has all but disappeared for the sector. Exploration & Production – May 15. Successful Efforts Exploration Success Successful Efforts Full Cost Only successful costs that Capitalized directly result in the finding of hydrocarbons are capitalized. Most E&P companies have not covered their cost of capital over the past ten years.. In the company specific section of the report. Exhibit 4 Source: Company data. Morgan Stanley Equity Research SEVA = Stern Stewart ROIC . One way to neutralize the impact of debt on valuation comparisons is to compare enterprise value to EBITDAX. depletion and amortization plus exploration expense). Many are forced to be more disciplined. one of the keys to financial success by an E&P company is a consistently low finding cost (Exhibit 5). As investors. Expensed Capitalized Capitalized Expensed Expensed Capitalized Capitalized Capitalized Capitalized Expensed Exploration Dry Hole Acquisition Costs Development Costs G&G Costs Production Costs amortization and exploration. Cash flow can be calculated from the top down (revenue minus cash costs) or from the bottom up (net income plus deferred taxes plus depreciation. depletion. we like to see a high return on equity.0% -6. Companies with a lot of debt generally sell at lower cash flow multiples. or only a return of capital? Comparisons between companies can also be difficult if they have different capital structures.0% 0. 2000 Please refer to important disclosures at the end of this report. dry hole costs) exploration expense is added back in order to put full cost and successful efforts companies on the same basis.

2000 Please refer to important disclosures at the end of this report.MORGAN STANLEY DEAN WITTER Page 6 Exhibit 5 5-Year Finding & Developing — A Data Point in Returns ($/BOE) 5 Year Average Finding and Development Costs $12 $10 $8 $6 $4 $2 $0 PXD SGY AVG RRC SFS BRR SFY COG KMG DVN HSE BR EOG THX APA Source: Company data. Moving one step forward. In the following exhibits we show this metric for both our U. A company that can replace production without using all its cash flow will have more financial flexibility than a company requiring all of its cash flow to replace production. Note: Burlington Resources F&D 3-yr. and Canadian peer groups. Excess cash flow gives a company the flexibility to re-invest in projects. Exploration & Production – May 15. XTO NEV NBL NFX UCL FST POG OEI UPR LD APC PPP . the combination of projected free cash generation and per share growth provides a compelling characteristic with which to begin the screening process. reduce debt or buy back stock.S. Morgan Stanley Dean Witter Equity Research. average.

more recently.00 /boe) Peak IV 1 5 Trans actions ($ 6 .6 1 /boe) 6 Trans actions $10. the Exhibit 7 financially strong can acquire cheaper reserves in times of weak commodity prices (Exhibit 7). . 2000 Please refer to important disclosures at the end of this report.0 Troug h III $14. (WTI/NG 12 M onth Stri p) $12. 1998-2001E 20% APC 15% NFX 10% EOG XT O APC/UPR* 5% BRR T HX SFS 0% $0.00 * Pro-forma for merger -15% RRC Source: Company data.00 $2.7 2 /boe) 1 8 Trans actions $20.00 $6.8 1 /boe) 1 1 Trans actions Troug h II ($ 4 .00 POG UPR OEI PXD VPI KMG $3.00 EEX -$1.17 /boe) 3 Trans actions Peak III ($ 5 .94 /boe) 1 0 Trans actions Troug h IV ($ 4 .0 Troug h I ($ 4 .MORGAN STANLEY DEAN WITTER Page 7 Exhibit 6 A Compelling Starting Point Free Cash Flow and Per Share Production Growth. Companies with excess cash flow and/or under-leveraged balance sheets can take advantage of their less endowed peers when the cycle turns against them.00 APA HSE DVN UCL -$3.00 -5% FST -10% NBL LD SFY BR $1. or.00 -$2.00 $4. weak stock prices. In other words.0 Source: Morgan Stanley Equity Research.00 $5. * Per BOE numbers reflect average global private market transactions. Exploration & Production – May 15.0 Peak I ($ 6 . BOE Transactions Track Commodity Price — Buy Wisely! $22.1 1/boe) 5 Trans actions $18.0 $16.0 Peak II ($6 . Herold’s. Morgan Stanley Dean Witter Research The Acquisition: We are dealing with a cyclical industry.0 15 P eri od M o ving Avg .

10/Mcf. Morgan Stanley’s recently revised forecast. The economics speak for themselves.0 0 $ 6 . The impact is close to 3% to after tax returns.90/Mcf for natural gas.3 4 7% E x h ib i t C $ 1 9 . and creates a strong company able to thrive in both good times and bad.9 0 $ 6 .9 0 $ 6 .6 3 17% Source: Morgan Stanley Dean Witter Research Exploration & Production – May 15.MORGAN STANLEY DEAN WITTER Page 8 A $ BOE improvement in purchase price equates to between 100 and 150 basis points in returns. Example A includes the longer term average historic commodity prices of $19.7 6 2% E x h i b it B $ 1 9 . . In Exhibit 8. we have modeled the average North American E&P company. It’s All About Discipline: The key is the capital discipline to spend money on only the highest return projects when prices are high.50/Mcf. as rig rates and personnel costs tend to rise with commodity prices.5 0 $ 1 .9 0 $ 6 .5 0 $ 1 . And while this is not absolutely real life.7 6 2% E x h i b it B $ 1 9 .5 0 $ 2 . we increase the natural gas price even further to $2. The change in returns — displayed at the top — shows the economic sensitivity to the moves. Capital discipline feeds on itself. Exhibit 8 E x a m p le I O i l P r i c e ( $ /B b l) N a tu r a l G a s P r i c e ( $ /M c f) F i n d in g C o s t p e r B O E R O I ( a fte r ta x ) E x h ib i t A $ 1 9 . Given the average cost structure of an E&P company.7 6 5% E x h ib i t C $ 1 9 .5 0 $ 1 .7 6 23% E x a m p le I I O i l P r i c e ( $ /B b l) N a tu r a l G a s P r i c e ( $ /M c f) F i n d in g C o s t p e r B O E R O I ( a fte r ta x ) E x h ib i t A $ 1 9 . Sensitivities Sensitivities: We would also like to show how small changes in long-term sustainable (if there is such a thing) commodity prices can have a dramatic impact on incremental returns on capital invested. In each of the examples we have held everything constant except long-term natural gas prices. and to avoid high-cost acquisitions when times are good.5 0 $ 6 . returns on investment have proven inadequate.5 0 $ 1 .50/bbl for crude oil and $1.9 0 $ 5 . In Example B. In Example C. 2000 Please refer to important disclosures at the end of this report. it goes a long way towards explaining leverage to the commodity.5 0 $ 2 . we increase the sustainable natural gas price by $0. on average.

54 0% 10% 10% 10% 34% 34% 34% Source: Morgan Stanley Dean Witter Research The “other” important variable we discussed previously is the expense necessary to replace reserves (i.55 $19.34 $0.40 0.50 $2.88 $0.76 60% 40% 100% 6.00 $12.00 $2.90 $0. C$0.35 $1.18 $0.00 $2.30 $1.18 $0.22 $0.5 $18. In Exhibit 10.500 $6.35 $2.35 $19. We have held commodities flat at historic levels.68 11.00 $1. returns on investment are 3%.30 $1.00 6.500 $6.42 Blended BOE $14.06 Blended BOE $12.40 $2.05 0. Finding & Development costs).00 $1.20 BOE Prices $15.30 $1. we’ve run various finding cost scenarios to measure return sensitivities.00 $12.00 $14.54 $0.30 $1.15 $19.22 $12.35 $19.00 $1.76 1.0 $1.00 $1.50 $2.00 $16.00 $2.68 11.50 $2.00 6.05 0. 2000 Please refer to important disclosures at the end of this report.00 $16.90 Natural Gas Commodity Prices Adjusted to Show Sensitivity Return on Invest Changes with Commodity Prices Realizations Natural Gas (C$ per MCF) Transportation Differential Nat.5 $18.90 $0.00 $0.76 1.00 $0.42 3.20 BOE Prices $12.00 6.40 0.76 60% 40% 100% 6.90 Example C $ 35% 23% 7.40 0.0 $2.76 60% 40% 100% 6. impacting F&D on a per BOE basis.68 in Canada) $ 3% 2% 7.0 $2.00 $16.65 $19.12 0% $12.22 3. and changed the numbers of barrels found.06 3.50 $2.35 0% $14.50 $2.05 0.42 $0.10 $12. As the per barrel cost is reduced returns rise to more compelling levels (Examples B & C).00 $2.5 $18.MORGAN STANLEY DEAN WITTER Page 9 Exhibit 9 Cost Optimization Model — The Incremental Return Impact of Sustainable Rising Natural Gas Prices Example A Return on Investment (Pretax) Return on Investment (After Tax) Targeted Reserve Life Cost Per Producing Barrel Cost Per BOE of Proven Reserves Percent Gas Percent Oil Total Nat Gas Conversion Ratio Pricing Assumptions Natural Gas (US$ per MCF) Nat Gas Trans Cost (US$/MCF) Crude Oil (US$/Bbl) Crude Oil Quality Differential (US$/Bbl) Crude Oil Trans Cost (US$/Bbl) Exchange Rate (i.88 $2.79 $1.35 $19.06 $0.20 BOE Prices $11.76 1.68 11.e. In Exhibit 9 Example A.06 $0. Exploration & Production – May 15.500 $6.88 $0. Gas Realization Crude Oil (C$/Bbl) Quality Differential Transportation Differential Crude Oil Realization Per BOE Analysis Revenue Royalties Net Revenue Op Cost Exploration Expense DD&A G&A Interest Total Cost Pretax Income Taxes After Tax Income Blended BOE $12.30 Example B $ 8% 5% 7.30 $1.10 $9. .e.50 $0.30 $1.35 $1.10 $9.50 $0..50 $2.

50 $2.20 BOE Prices $11.40 0.0 $18.93 0% 10% 10% 10% 34% 34% 34% Source: Morgan Stanley Dean Witter Research Exploration & Production – May 15.50 $2.00 $12.10 $9.35 $19.00 5.00 $16.500 $5. 2000 Please refer to important disclosures at the end of this report.06 $0.06 $0.06 Blended BOE $12.06 $0.40 0.34 1.5 $18.05 0.55 $19.63 60% 40% 100% 6.68 11.10 $9.00 $16.06 3.e.20 BOE Prices $11. .90 $0.00 $1.35 $1.30 $1.55 $19. C$0.00 $12.30 $1.42 $0.00 6.50 $2.35 $19.12 0% $12.30 $1.88 $0.10 $9.64 $1.50 $2.35 $1.40 $2.90 $0.35 $19.0 $18.63 1.30 Example B $ 10% 7% 8.34 60% 40% 100% 6.06 3.00 $1.22 $0.42 0% $12.48 $0.76 1.55 $19.05 0.30 $1.06 Blended BOE $12.90 $0.30 Commodity Prices Held Flat Return on Invest Changes with the Replacement Cost per BOE Realizations Natural Gas (C$ per MCF) Transportation Differential Nat.30 $1.00 $1.42 $0.0 $1.18 $0.90 $0.06 $0.64 $0.500 $6.00 $1.30 Example C $ 25% 17% 9.00 $16.06 $12.00 $12. Gas Realization Crude Oil (C$/Bbl) Quality Differential Transportation Differential Crude Oil Realization Per BOE Analysis Revenue Royalties Net Revenue Op Cost Exploration Expense DD&A G&A Interest Total Cost Pretax Income Taxes After Tax Income Blended BOE $12.50 $2.20 BOE Prices $11.30 $1.40 0.90 $0.05 0.56 10.35 $1.06 3.68 in Canada) $ 3% 2% 7.00 $1. F&D Remains Key Component of Incremental Investment Example A Return on Investment (Pretax) Return on Investment (After Tax) Targeted Reserve Life Cost Per Producing Barrel Cost Per BOE of Proven Reserves Percent Gas Percent Oil Total Nat Gas Conversion Ratio Pricing Assumptions Natural Gas (US$ per MCF) Nat Gas Trans Cost (US$/MCF) Crude Oil (US$/Bbl) Crude Oil Quality Differential (US$/Bbl) Crude Oil Trans Cost (US$/Bbl) Exchange Rate (i.MORGAN STANLEY DEAN WITTER Page 10 Exhibit 10 Other than Commodity Prices.90 $0.63 11.50 $2.500 $6.0 $1.40 $2.40 $2.0 $1.76 60% 40% 100% 6.00 6.00 $1.

the longer term E&P investment will remain under pressure. 2000 Please refer to important disclosures at the end of this report. Note: We have used the large cap index. Exhibit 12 Energy Component of S&P Index Keeps Falling Percent of S&P 500 % 25 20 15 10 5 0 1980 Energy Sector 1985 1990 Integrated Oils 1995 60/40 Gas/Oil 12 Month Strip. where the balance sheet is less of a factor. However. And since the Energy weighting has declined to only 8% of the S&P today (Exhibit 12).50/mcf Natural Gas) Forward Cash Flow trailing peak cycle valuation by 40% 2001E implied valuation by 17% 5.5 $10 $8 2. and still see upside in the current cycle. Commodity and Index Valuations $22 7. 1999 Forward P/CF Multiple. the market will only “invest” in E&P stocks if they can provide compelling company-specific reasons.5 $20 6. In the following exhibit.5 $12 3.5 7/ 08 10 /94 /2 1/ 9 2/ 4 03 /9 5/ 5 19 /9 9/ 5 01 12 /95 /1 5/ 9 3/ 5 29 /9 7/ 6 12 10 /96 /2 5/ 9 2/ 6 07 /9 5/ 7 23 / 9/ 97 05 12 /97 /1 9/ 9 4/ 7 03 / 7/ 98 17 10 /98 /3 0/ 9 2/ 8 12 / 5/ 99 28 /9 9/ 9 10 12 /99 /2 3/ 9 4/ 9 07 /0 20 0 00 E Source: MSDW Equity Research. be opportunistic and high grade into strength. we have graphed Price to Forward Cash Flow for the group. investors have often viewed E&P stocks as trading vehicles. 40% crude oil). which is risky in cyclical groups. A better proxy for the mid-cap stocks is EV / EBITDA. Until returns are a “real” industry focus and can be generated across the cycle.5 $18 $16 $14 4.5 MSDW 2000E Commodity Strip ($20/bbl Crude Oil / $2. We agree with this assessment. E = MSDW Research Estimates (data measured through 12/03/99).MORGAN STANLEY DEAN WITTER Page 11 Today’s Investment Perspective In summary. Source: Morgan Stanley Dean Witter Research Exploration & Production – May 15. .50/Mcf natural gas we still see upside approaching 20% today. and we are recommending that investors move around in the names. relative to a commodity index (60% Exhibit 11 natural gas. many company specific names are beginning to stretch historic valuation parameters. Using our MSDW normalized commodity forecasts of $20/bbl oil and $2.

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