Energy Picks for 2007

We're always looking for energy trends that have long-term legs and plenty of forward momentum to overcome near-term oil and gas price volatility. Here are some energy stocks worth noting for 2007, thanks to frontier oil and gas discoveries and projects. Discoveries in 2006 revealed and confirmed several exciting new frontiers in the deep-water Gulf of Mexico, onshore gas shale basins in the United States, and oil sands in Canada. Technical advances in finding and extracting oil and gas--not just higher oil and gas prices--have made these frontier fields possible. Several companies are now poised for growth from new well hookups or project startups this year.

2007 Energy Picks Among Frontier Producers
2007 could be a banner year, with major projects to drive up production at several energy companies with frontier fields. In deep-water Gulf of Mexico, startup of the Independence Hub operated by  Enterprise Products Partners (EPD) will hook up 10 deep-water wells to transport natural-gas production to the mainland. Drilling in the Woodford Shale gas shale basin in Oklahoma could drive up natural-gas production for  Newfield Exploration . And, startup of the first phase of oil sands production at  Nexen's  Long Lake project in Canada remains on track for 2007. In the table below, we've provided a sample of energy companies we think have long-term project-driven upsides that will help ride out near-term oil and gas price swings.

Frontier Oil & Gas Companies - North America
	Morningstar Rating	Fair Value Estimate ($)	Price/ Fair Value	Market Cap ($bil)
Deepwater Gulf of Mexico
Anadarko Petroleum		55	79%	20.1
Devon Energy (DVN)		93	75%	30.7
Enterprise Prod (EPD)		35	85%	12.9
Norsk Hydro (NHY)		35	87%	38.0
U.S. Gas Shale
Chesapeake Energy		45	66%	13.0
Devon Energy (DVN)		93	75%	30.7
EOG Resources (EOG)		77	88%	16.4
Newfield Exploration		57	74%	5.5
Canadian Oil Sands
Canadian Nat. Res. (CNQ)		53	93%	26.4
Nexen		55	112%	16.1
Data as of 01-23-07

What Made These Frontier Fields Possible?
Technical advances have been the common thread behind frontier plays. These include enhanced seismic and deep-water drilling equipment, better methods to fracture shale and other tightly packed formations, and improved processes to render thick, tar-like oil sands into higher-grade crude oil. New technology helped make these fields economical, not just higher oil and gas prices, and this paves the way for profitable production growth through price cycles.

Why New Technology Matters--Production Growth Marches on
Oil and gas producers can now get a better understanding of underlying oil and gas structures using 3D seismic drilling and then directional drilling to reach deeper zones, as well as new fracturing (or well stimulation methods) to extract more oil and gas from formations. These advances help reduce exploration costs or increase production per well by getting more oil and gas out of the ground. This has opened the door to more economic fields, even at lower-than-current oil and gas prices. E&P companies can forge ahead with production growth plans over a long-term price cycle.

Deep-water Gulf of Mexico Is Less of a Mystery
Deep-water Gulf of Mexico oil and gas discoveries have been accelerating over the past few years, attracting the return of major oil companies to the Gulf. For 2007, we expect to see a major boost in deep-water gas production with the mid-2007 startup of the Independence Hub that will tie in 10 (yes 10) deep-water wells and transport production onshore. This is why we like Enterprise Products Partners as the operator of the hub and hub partners,  Anadarko Petroleum  and  Devon Energy (DVN). We also look for other companies to follow  Norsk Hydro's (NHY) example in 2006 and buy up companies or assets operating at water depths of more than 1,000 feet.  Chevron's (CVX) Jack 2 deep-water well with preliminary indications of a new giant field has sparked an interest in deeper Lower Tertiary formations in the deep-water fields. But this is just one of more than a dozen promising discoveries to support several years of drilling and production. New technology has made these discoveries possible with advances in 3D seismic surveys, allowing companies to determine rock formations below opaque salt domes. Drill ships can now drill in more than 5,000 feet of water and then another 10,000 feet of solid ground to reach deep formations. Remote-operated vehicles can install sub-sea manifolds over wells and pipelines transporting oil and gas from these wells to floating production platforms and then onward to onshore pipelines. Make no mistake, these are high-cost wells, with production startup a good three to five years after a discovery. However, producers now have a better understanding of the oil and gas formations, netting higher drilling success rates of a commendable 63% in the Lower Tertiary. We look for steady production gains from deep-water Gulf of Mexico fields over several years, thanks to these discoveries.

Producers Are Applying Lessons Learned
Next in the wave of tight gas shale fields to log hefty production gains may be in southeastern Oklahoma's Woodford Shale, and we look for a step-up in production in 2007 from Newfield Exploration and Devon Energy. Again, technical advances in fracturing gas-bearing shale to promote the flow of gas through horizontal wells were the primary driver behind rapid production growth in the prolific Barnett Shale basin in Texas and  EOG Resources' (EOG) fortunes over the past three years. Then came success in the Fayetteville Shale in Arkansas. Lessons learned in drilling horizontal wells and testing ways to fracture gas shale rock in the Barnett Shale and Fayetteville Shale can be applied to the Woodford Shale. Newfield Exploration's early and low-cost move to acquire Woodford Shale property--plus drilling lessons learned in 2006--should bear fruit in 2007 with large production gains. Devon Energy again has a foothold in a frontier basin, with well-placed acreage in the Woodford. The next stop may be Appalachia, with  Chesapeake Energy  and other firms testing horizontal wells in 2006 and 2007.

When Tar Sands Became Oil Sands
Technological advances enabled western Canada's extensive tar sands formations to become oil sands, and infrastructure development is on track for production gains for at least 10 years. We like how Nexen and  Canadian Natural Resources (CNQ) have major oil sands projects lined up for phased production startups over the next two years. These oil sand formations have been known for years, but it took advances in heating and treating these tar-like sands to enable the flow of heavy oil embedded in the sand or rendering this thick, impurities-laden bitumen into usable synthetic crude, which can be blended and transported to refineries and end users. Nexen's Long Lake Project with partner OPTI Canada in the Athabasca oil sands region of northeastern Alberta is initiating its Phase 1 development with the 2007 startup of its bitumen upgrader to produce synthetic crude. Canadian Natural Resources' Horizon Oil Sands Project in the same region of Alberta expects to produce synthetic crude in 2008 as part of its three-phase development program over seven years from 2005-12. With so much oil sands production under development, more infrastructure projects, such as pipelines and heavy crude oil refining capacity expansions, are also under way. We look for oil sands production growth to continue for more than 10 years, as producers chip away at these massive fields.