During 2004, virtually all upstream stock prices increased, many of them to new highs. For some, it was a matter of mere math: rising commodity prices simply lifted all boats. So, which E&P stocks are true stand-outs for 2005? Oil and Gas Investor surveyed several analysts for their favorites among small-cap stocks and larger issues. Micro-caps Mission Resources Corp. and ATP Oil & Gas Corp. qualify as under-the-radar hot stock picks, according to Curtis R. Trimble, an analyst at Baltimore-based Ferris, Baker Watts Inc. Mission Resources Corp. Trimble commends $243-million-market-cap Mission Resources (Nasdaq: MSSN) for its drilling and restructuring strategies during the past year. Management and directors retained Petrie Parkman & Co. during 2004 to assist with strategic review of the company's direction. But, rather than an exit, the Houston-based producer, which focuses on the Permian, Gulf Coast and Gulf of Mexico, decided to push forward. "In 2003, Mission enjoyed a successful drilling program, completing 85.8% net wells drilled," Trimble says. The company's exploration-drilling program had a 71% success rate on 13 wells. Its capex for 2004 grew to some $52 million from $34 million. And, new management reduced the company's $169.5 million of debt from 63% of book capital to 50%. "We feel that a strong commodity-price environment and recent drilling successes have eliminated much of the liquidity problems that constrained Mission's growth in recent periods," Trimble says. "Mission's reserve base and prospective near-term production growth offer investors a very attractive risk-reward proposition at current levels." Mission needed to achieve financial stability, but it also faced the challenge of reinvigorating a stagnant drilling program, Trimble adds. Jack Eells, formerly head of El Paso's Gulf Coast operations, is largely responsible for the development of Mission's exploration program. Eells has brought Mission experience in its core Gulf Coast, South Texas and Permian Basin efforts. "Mission achieved significant production increases in a cost-efficient manner, reducing cash operating costs from $3.33 per thousand cubic feet equivalent in 2003 to an estimated $2.77 in 2004. This level of cash costs is equal on a per-unit basis with costs in 2002, despite a 26% decline in production due to asset sales." During the past six quarters, Mission refinanced its debt, divested oil-producing properties with sky-high operating costs, acquired the gas-rich Jalmat Field in the Permian Basin, and engaged in successful drilling projects. While capital expenditures for 2004 were expected to exceed $50 million, Trimble anticipates a 20% to 25% increase in 2005 to more than $60 million-which can make way for the company to make numerous acquisitions and debt-reduction payments. "In our view, the turnaround phase of Mission Resources is largely completed." He had a Buy on the stock in late November and a $12 price target. At the time, shares were $5.71 each, and the 52-week range was $1.62 to $7.02. ATP Oil & Gas Corp. Trimble's other E&P darling is Houston-based ATP Oil & Gas (Nasdaq: ATPG), which had a recent market capitalization of approximately $325 million and is focused in the Gulf of Mexico and the U.K. North Sea. While ATP suffered from shut-in production in the Gulf of Mexico after Hurricane Ivan last year, all but one of its operated properties were back online and producing in November. ATP's track record, for many, was overlooked in 2004. It successfully developed 11 wells on six of its properties, including Matagorda Island 704, West Cameron 237 and Ship Shoal 358. Two additional wells, both at West Cameron 237, have been completed as well and are to begin producing in this quarter. Its 2004 production was expected to total some 24 billion cubic feet equivalent (Bcfe). Trimble adds that ATP has made steady progress in improving its financial flexibility. In September 2004, it amended a $185-million term loan that was put in place in March, reducing the interest rate and raising the principle to $200 million. This funding, along with strong cash flow, put ATP in a position to fulfill development plans. "For the balance of early 2005, we expect the company to focus its efforts on smaller projects with shorter lead times, a prescient decision given the recent, unprecedented strength in commodity prices," Trimble says. He expects ATP will transfer between 40- and 50 Bcfe of its 247 Bcfe of proved undeveloped reserves to the proved developed category. At press time, Trimble had a Buy on shares of ATP and a price target of $22. At the time, shares were trading at $13.32 each and the 52-week range was $3.92 to $15. Sterne, Agee & Leach's E&P analyst, Michael Bodino, seconds the recommendation of ATP. "ATP is another name that I picked up in January 2004," he says. "It was a stock left for dead that was not well liked, but its unique strategy propelled the stock from around $5 at the beginning of 2004 to $13." He sees ATP as a unique offshore E&P company. "Although more an exploitation and production company than an exploration company, ATP is as unconventional as the many companies that focus E&P activities on developing shales, coalbed-methane and tight-gas sands. Very similarly, ATP has low reserve and reinvestment risk, while applying a level of technical proficiency necessary for the economic development of its projects." He expects year-end 2004 figures will show that ATP, during 2002-04, generated a 95% rate of return, spent approximately 85% of its operating cash flow, and replaced 377% of its production. In late November, Bodino had a Buy rating on shares of ATP and a price target of $18. In addition to ATP, Bodino points to other diamonds in the rough: small-caps Delta Petroleum Corp. and Southwestern Energy Co. "We have been very fortunate to identify and push unique ideas [in 2004]," he says. Delta Petroleum Corp. Bodino initiated coverage on $555-million-market-cap Delta Petroleum (Nasdaq: DPTR) at $6.20. At press time, the stock was $13.29 a share, and the 52-week range was $4.75 to $15.93. "I am the only analyst covering it, and the company is pushing a $600-million enterprise value." For Delta, smart acquisitions have been key. "Through a series of strategic acquisitions, Delta has positioned itself for rapid organic growth," the analyst says. This past summer, the Denver-based producer bought more than 90 Bcfe of proved reserves on the Texas and Louisiana coasts from Houston-based Alpine Resources for $122.5 million. The assets are 95% operated, 50% gas and contain 140 Bcfe of total reserve potential. As a small E&P with only 90 Bcfe of proved reserves, Delta still has several projects in the works that could each increase its reserve base, including Fuller Reservoir and Trailblazer, both in Wyoming. Wells in these areas have the potential to fuel production growth, spark a rapid increase in per-share earnings and cash flow, and improve Delta's underlying net-asset-value growth, Bodino says. At press time, he had a Buy on Delta shares and a price target of $18. Southwestern Energy Co. "Southwestern Energy is one of my favorites," Bodino adds. Shares of the gas-focused, Houston-based producer that trade on the New York Stock Exchange as SWN, were $48.57 each, giving the company a market capitalization of $1.8 billion. The 52-week range was $19.11 to $51.19. "The stock went from $20 to $50 in 2004, although the story is nothing more than an execution story-the company was a great turnaround story from last year. In fact, in the time it took Ultra Petroleum to go from $8 to $50, Southwestern has gone from $10 to $50 since the beginning of 2003," Bodino says. Southwestern appears to have an adequate drilling inventory in its core areas that provide growth and earnings visibility well into 2006 at attractive rates of return, Bodino adds. The company has been successful in its Overton Field in East Texas and on its Arkoma Basin acreage, while simultaneously developing new areas, including River Ridge in Lea County, New Mexico, and Stockman in Shelby County, East Texas. The company is also involved in projects in new-venture areas and in South Louisiana where it is poised for further growth if successful. At press time, Bodino had a Buy rating on Southwestern shares and a price target of $52. JPMorgan's E&P analyst, Shannon Nome, picks two large caps as stocks to watch in 2005: EOG Resources Inc. (NYSE: EOG), which had a market cap at press time of $8.5 billion, and Newfield Exploration Co. (NYSE: NFX), which had a market cap of $3.7 billion. EOG Resources Inc. Although EOG is known in part for its efforts in the Barnett Shale, Nome says its portfolio of other resource plays should add significant value during the next several years. "Specifically, 29 different basin-centered gas plays in the Rockies, Midcontinent and South Texas regions will command nearly 40% of North American capex [this] year, and many offer minimum net unrisked play potential of 100- to 200 Bcfe." The Uinta Mesaverde play in the Chapita Wells/Natural Buttes fields in Utah offers substantial upside via downspacing potential from 80 acres currently, and resembles the Piceance Basin years before 10-acre infill drilling came along, Nome says. EOG is also positive about its Canadian coalbed-methane potential in the Twining Field in Alberta, where the company holds 130,000 acres and plans 100 to 200 wells per year. The company is not well known for larger-impact, single-well exploration, but still has some very important tests coming up during the next six to 12 months in Trinidad, Canada and South Louisiana. Though investors have tended to view EOG's international portfolio with skepticism in light of the small contributions to date from the North Sea, and the deflated gas price linked to Trinidad production, Nome says the company is now managing very respectable growth from both regions. "We continue to rank EOG as our top overall large-cap E&P pick," Nome says. She has an Overweight rating on the stock. (Nome does not issue price targets.) She expects "further catalysts will unfold for the stock as additional drilling results in the Barnett Shale come to light in the months and quarters to come." At press time, EOG shares were $68 and the 52-week range was $41.60 to $72.48. Newfield Exploration Co. One of Nome's original concerns was the way Newfield's production mix remained so concentrated in the Gulf of Mexico, at nearly half of total volumes. But, the company has been in serious transition during the past two to three years, and during that time has successfully diversified its asset base far beyond its Gulf roots. "Following relatively middling share-price performance during most of that transition period, we believe the stock is at an important inflection point, and we see appreciable outperformance ahead," she says. "Based on upcoming drilling plans, we believe Newfield's story is more catalyst-rich than it has been in a number of years." Newfield slowly weaned itself from its dependence on the Gulf of Mexico, opting to expand onshore though a series of acquisitions. Thanks to these purchases and to successful drilling, Newfield's offshore production has been reduced to roughly 40% of the company-wide total. During the past two years, the Midcontinent and Rocky Mountain regions have grown to represent 40% of the company's reserves. Midcontinent production has grown organically by almost 50%, and Newfield has more than doubled its acreage position during the past 24 months. Newfield's conventional Gulf-shelf efforts have produced strong results, especially considering industry-wide struggles to offset natural declines in the region. "While Gulf production as a whole has been falling, Newfield has managed to modestly grow its offshore production base without the benefit of major acquisitions since 1999-excluding the [recent] Denbury transaction," Nome says. An aspect of the company's offshore program that should pique investors' attention is the emerging ultradeep shelf Treasure Island play. Newfield holds 45% to 100% interest in more than 80 blocks that are ultradeep gas prospects. "While this is truly an untested, frontier play that will pose significant drilling challenges, we believe Newfield, operator ExxonMobil and its [other] partners have done extensive analysis and prepwork that will maximize the chance of success," Nome says. The company is also attempting to establish a North Sea presence; it has opened a London office and acquired one lease block as well as a nonoperated interest in the Windermere and Chiswick fields in the Southern Gas Basin. Its entry into Malaysia also may make way for exploration upside, which is one more reason to keep it on the radar this year, she adds. At press time, Nome had an Overweight rating on NFX. Shares were $57.71 and the 52-week range was $39.59 to $65.83. Talisman Energy Inc. Another E&P stock to watch is large-cap, Calgary-based Talisman Energy Inc. (NYSE, Toronto: TLM) Why? Morgan Stanley's large-cap E&P analyst, Lloyd Byrne, points to the company's growth opportunities, especially in the Trenton/Black River (TBR) in the Appalachian Basin. The play is technically sophisticated and geologically complex. And, in Byrne's view, the US$10.1-billion-market-cap company is getting in on the ground floor. "Only now are participants beginning to understand the grabean structures, benefits of horizontal drilling, ensuing decline rates and ultimately, the region's potential," he says. While the area may not carry the notoriety of the Barnett Shale, Byrne says it shouldn't be overlooked. "The play's anonymity is largely tied to its infancy and the barriers to entry that exist for new entrants, limiting publicity surrounding it," he says. "With that said, though, TBR sits in the backyard of three major consuming regions, has an internal rate of return more than 20%, gets priced at a premium to Nymex, and has plenty of operational running room, in our view." Production by Fortuna Energy, Talisman's subsidiary in the TBR, has grown to 110 million cubic feet per day, or 10% of company-wide North American output. The potential for further growth is significant-but the play is a challenging one, rife with many unconventional and complex characteristics, Byrne says. At press time, Byrne had an Overweight rating on Talisman shares and a target price of C$39, versus a late-November market price of C$31.35 a share. The stock's 52-week range was C$21.67 to C$35.10 at the time. Brad Beago, an E&P analyst with Calyon Securities (USA) Inc., says midcaps Denbury Resources Inc., Comstock Resources Inc. and Vintage Petroleum Inc. are among exceptional E&P stocks. He points to unique CO2 assets for Denbury, says that Comstock's roll-out of its Gulf of Mexico operations through a combination with those of Bois d'Arc Energy LLC was a strategic move, and believes Vintage is simply a classic turnaround value play. Denbury Resources Inc. Plano, Texas-based Denbury (NYSE: DNR) recently sold its Gulf of Mexico assets to Newfield Exploration and is now focused exclusively onshore the U.S. It is the largest operator in Mississippi, owns the largest CO2 reserves for tertiary oil recovery east of the Mississippi River, and holds operating acreage onshore Louisiana. "Denbury's CO2 project, which is key to our investment thesis, appears on track," Beago says. "In fact, CO2 volumes were ahead of our estimates for fourth-quarter 2004. Volumes from the company's tertiary recovery operations were nearly 7,000 barrels per day, up 360 from second-quarter 2004." Denbury projects the output will grow during the next six years to 50,000 barrels per day. "We view the stock as a unique long-term growth story and believe that this type of low-risk growth should excite investors," Beago says. Denbury also completed its fourth CO2 well in 2004, adding an extra 300 Bcf of CO2 reserves, resulting in an estimated total increase in CO2 reserves during 2004 of approximately 1 trillion cubic feet. Beago adds that the $1.5-billion-market-cap company is in the best financial position it has been in years. Its net debt-to-capitalization was only 17% recently and fourth-quarter 2004 debt was less than Beago's 2004 EBITDA estimate. In addition, Denbury invested 47% of its 2004 capex into accelerating its CO2 play, Beago adds. In late November, he had a Neutral recommendation on Denbury shares and price target of $30. The shares were $25.58 at the time and a 52-week price range of between $11.54 and $27.47. Comstock Resources Inc. Beago is confident in the development of Frisco, Texas-based Comstock Resources (NYSE: CRK). "The company has a very impressive portfolio of prospects," he says. In East Texas and North Louisiana, it expects to drill 50 wells in 2005 and increase production by 10 million cubic feet per day. In Southeast Texas, the company is drilling a southward extension of the successful Ross prospect and plans to test its Big Sandy prospect, which has 100-plus Bcf of potential, he adds. In the Gulf of Mexico, Comstock rolled its assets into privately held Bois d' Arc this past summer in exchange for stock and plans an initial public offering of the Gulf-focused operators' shares. Bois d'Arc was drilling three wells in the fourth quarter and planned three more by year-end. Additionally, Beago says, Comstock bought onshore-focused Ovation Energy in 2004 for $62.5 million, providing opportunities in the Arkoma and Anadarko basins. Beago had an Add on $755-million-market-cap Comstock shares in late November and a price target of $25 per share. The stock was trading at the time at $19.99 and the 52-week range was $15.92 to $24.46. Vintage Petroleum Inc. Tulsa-based Vintage's 2004 exploration costs exceeded Beago's estimate. "[But] exploration costs are a part of doing business in the oil patch," he says. "For companies such as Vintage, that use the successful-efforts accounting method, exploration charge volatility is common and can skew reported earnings up or down, especially on a quarterly basis." His investment thesis on Vintage (NYSE: VPI) remains intact and his outlook is bright. "The company is selling its Canadian properties and focusing, with much success, on its U.S., Argentine and Yemeni operations. The balance sheet is in good shape and the company put in some new hedges that should help ensure strong price realizations throughout 2005." He had a Buy recommendation on shares of $1.4-billion-market-cap Vintage in late November and a $25 price target. Shares were trading at $21 each and the 52-week range was $10.14 to $21.95. Choosing stocks Although there is no simple formula for finding an exceptional E&P stock, these analysts have ideas on how to approach the task. "To be an exceptional performing company, I believe corporate production and reserve growth have to be robust enough to offset any commodity-price weakness," Bodino says. "Variances in value creation and growth in production, reserves, earnings and cash flow have dictated whether a company has outperformed or underperformed the group. Even in 2001, there were stocks that had positive stock-price returns even though oil and gas prices trended down." Assets are also key. Says Byrne, "Exceptional E&P stocks need to have the assets in place to redeploy free cash flow most efficiently, in order to generate leading returns and growth." Nome adds that key determinants of E&P success in 2005 will be low-capital-intensity assets or a production base that does not require immense capital spending to maintain flat production; significant free cash flow generation; and a large prospect inventory-particularly of lower-risk, visible growth projects. WHAT TO LOOK FOR Exceptional E&P companies have the following attributes, according to Curtis Trimble, an E&P analyst with Baltimore-based Ferris, Baker Watts Inc. Relentless pursuit and execution of a consistent operating strategy. "With the degree of operating flexibility now afforded E&P companies by long-term price contracts, there exists little reason to deviate from strategies that have been successful in the past because of price volatility. Prudent management teams will use the current high price environment to strengthen both their property portfolios and their balance sheets, in order to avoid the classic cyclical bust phenomena of overspending in the up-cycle, leaving nothing for the down-cycle." Increased rates of technological adoption. "Oilfield technology offers much upside to reserve and production growth for smaller companies. Many smaller companies have leaped onto the 3-D seismic bandwagon at the front-end of their exploration and development programs only to drop the ball through the completion and production phases. "Adoption of advancements in directional drilling, fracturing and completion products and methods, production modeling, field development, and compression have all been woefully inadequate, especially among smaller market participants. With the major discoveries already made in North America, the most successful E&P companies will focus more of their attention and more of their capital expenditures on driving incremental production growth from existing reservoirs." Heightened creativity in developing alliances and risk-sharing arrangements. "Many E&P companies have developed much closer relationships with their banks as a result of the increase in the use of derivative financial instruments. That degree of cooperation should carry over to a greater extent to the services side of the business." Stable management teams. "Most likely if members of management retain their jobs, they've done a good job executing on the above three topics. Coincidentally, in order to achieve the three aforementioned objectives, a company needs to retain its core executives."