A lot of jittery investors these days appear to be buying into market fears that commodity prices and oil and gas stocks are ready to tank. But many savvy energy analysts aren't in that number, and based on the surge in their total capital spending so far this year-including upstream spending-neither are independent producers.

According to Wayne Andrews, managing director and senior E&P analyst for Raymond James & Associates in Houston, total capital spending in first-half 2006 by the 48 E&P companies in his coverage universe increased 39%, to $32 billion, from the like 2005 period.

This consisted of $20.6 billion for E&D (exploration and development)-representing 64% of total outlays and a jump of 35% versus the first six months of 2005-$9.2 billion for property acquisitions and $2.2 billion for stock buybacks.

"Our updated forecast for full-year 2006 is for E&D budgets to total $43.1 billion, implying a growth of 26% over 2005 exploration and development spending and 10% more than initial budgets for 2006," says Andrews.

This projected $43.1 billion in 2006 E&D spending is nearly triple the $15.4 billion that his producer universe budgeted for 2002 and, given the analyst's aggregate $51.2-billion cash-flow forecast for 2006, leaves plenty of room for acquisitions and/or stock buybacks.

With capex spending on the rise, E&P investment strategy reflects a continuing sense of optimism about industry fundamentals, particularly the strong outlook for cash flow, the market seer contends.

"We have long argued that debt-adjusted growth in reserves and production is the surest way of enhancing shareholder value and emphasize that rising capex spending will sustain growth in production volumes," says Andrews. "E&P profitability also continues to look compelling, even with rising service costs and volatile natural gas prices."

Naturally, it follows that higher upstream spending is also beneficial to oil-service companies. "This stimulates the already high demand for rigs, providing service firms the opportunity to push through further price hikes without jeopardizing the level of drilling activity," the analyst adds. He sees the biggest beneficiaries in the service sector as those companies with the most leverage to the drillbit, specifically U.S. land and offshore drillers, tubular manufacturers and other gas-weighted service providers.

Although crude oil prices have fallen recently to five-month lows, J. Marshall Adkins, director of energy equity research for Raymond James, still believes various international supply disruptions, coupled with escalating geopolitical risk, are likely to keep oil prices at elevated levels for the foreseeable future. His full-year 2006 forecast is for $67.56 oil and for full-year 2007, $70.

On the gas side, he maintains a bullish stance on the underlying long-term supply/demand fundamentals for that commodity and insists the market has overreacted to recent large storage injections. This year, he eyes average gas prices of $7.54; for full-year 2007, $10.

The implications of this outlook for E&P stocks? "Our large-cap group is trading at only $2.72 per Mcfe (thousand cubic feet equivalent) of proved reserves and 4.2 times estimated 2007 EBITDA (earnings before interest, taxes, depreciation and amortization)," says Andrews.

"While we continue to look for this entire group to move up with the strength in commodity prices, we believe the shares of Chesapeake Energy, Ultra Petroleum and XTO Energy will perform particularly well in light of our robust outlook for natural gas prices. All three companies have a high natural gas focus, solid margins, high organic production-growth rates, deep drilling inventories and notable hedging positions."

Admittedly, the small- and midcap stocks within the Raymond James coverage universe have recently been trading at slightly higher valuations ($3.36 per Mcfe of proved reserves and 4.3 times estimated 2007 EBITDA). However, there are still some diamonds in the rough.

Says Andrews, "Balancing current valuations, risk and per-share production growth opportunities, our top picks are Bois d'Arc Energy, CNX Gas, Comstock Resources, GeoMet, Goodrich Petroleum and Range Resources."