January 7, 2002; Natural Gas the Base of Energy Prosperity

The high valuation of energy infrastructure partnerships seems out of line with the depressed valuation of natural gas production.  Of course general partners can declare steady distributions while the value of natural gas fluctuates every day in the futures market.  Yet the predictability investors may pay for often turns out to be false. 

Fundamentally, infrastructure is perceived as a lower-risk business than production.  High debt negates that advantage, in our opinion.  Moreover the trend toward deregulation should lead to lower, not higher debt.  Historically in a regulated environment the customer ratepayers shared the risk of business fluctuation by paying a return based on investment rather than current conditions.  

One needs to look no further than inventories to see why natural gas stocks are depressed.  An economic slowdown and warm weather have reduced demand below what producers anticipated when they drilled new wells a year ago.  Drillers have cut back, but the lag between drilling and consumption means natural gas in storage has accumulated to high levels.  That is a classic business cycle.  Just as the cycle has turned down, it will surely turn up again.

We are gradually building a product line of recommended natural gas producer investments that now includes one in each size category of large cap, mid cap, small cap, royalty trust and micro cap.  All are attractive commitments today, in our opinion.  The timing may not be strong for sharp immediate appreciation and there may even be further temporary weakness, if not stagnation.  From a cyclical point of view we think we may be near the end of the down slope and may be on the up slope again by, perhaps, mid year.