Jim Cramer says it's time to buy the oil patch.

Fine, but walk deliberately. No question, the Royal Dutch/Shell bid for Barrett Resources (BRR:NYSE - news - boards) increased visibility in the group and placed a keen focus on the valuations of companies in the energy business. That doesn't mean you should indiscriminately jump on the energy bandwagon.

"The Shell-Barrett deal should catch your attention," says Dan Pickering, director of research at Simmons & Co., a Houston energy investment bank. "It is an indicator that there are clearly some attractive fundamentals and valuations in the exploration and production world."

But, Pickering suggests, Shell isn't the bellwether it once was. "Shell has lost a lot of luster in the past few years," he notes. "Exxon Mobil (XOM:NYSE - news - boards) has really taken its place at the top of the admired list."

Still, the offer presents opportunities. Jim is right: When a company is willing to fight for control of another for such a premium, someone smells value. That is true here, especially if you consider the major energy companies -- Shell, Exxon, BPAmoco (BP:NYSE - news - boards) -- couldn't move fast enough to exit the North American natural gas market in the 1990s.

The change of heart and the willingness to pay such a premium to return to a business you once spurned speak volumes about the fundamentals of the business. The question is: what business?

It's natural gas, period. "Can you buy the oil patch on this news?" asks Pickering. "No. This is a gas play. Barrett is 96% natural gas. They are clearly making a natural gas decision, not an oil decision."

Trend or Smoke Screen?

The other question on the minds of investors is whether Shell's premium offer for Barrett is a precursor of deals to come. Does Shell's deal open the gates to more merger and acquisition activity in the natural gas space?

At least one analyst thinks it does. "The industry participants have recognized the gap between current equity market valuations and the longer-term outlook for commodity prices and are taking advantage of the disparity," Raymond James exploration and production, or E&P, analyst Wayne Andrews told clients Thursday morning. "This has sparked a major merger frenzy that we expect to continue until the valuation gap narrows."

Banc of America energy analyst Mark Fischer takes that thesis a step further. He suggests that if E&P companies with significant gas assets were to reach the valuation implied in the Shell offer for Barrett, the appreciation potential of the average E&P company's stock would be over 75%.

Gas-Powered Portfolio Natural Gas Stocks Could Soar if Shell Sets the Price
Company & Ticker	Stock Price 3/7/2001	Market Cap ($ mil.)	Modeled Takeout Price*	% Change from 3/7
Barrett Resources (BRR:NYSE)	$61.11	$2,073	$55.00	-10.0%
Burlington Resources (BR:NYSE)	49.96	10,790	73.00	46.1
Cabot Oil & Gas (COG:NYSE)	30.01	887	50.00	66.6
Devon Energy (DVN:NYSE)	63.58	8,470	101.00	58.9
EEX Corp (EEX:NYSE)	4.55	191	23.00	405.5
EOG Resources (EOG:NYSE)	48.78	5,834	59.00	21.0
Forest Oil (FST:NYSE)	35.30	1,765	63.00	78.5
Louis Dreyfus Natural Gas (LD:NYSE)	40.40	1,809	76.00	88.1
St. Mary Land & Exp. (MARY:Nasdaq)	25.13	721	36.00	43.3
Newfield Exploration (NFX:NYSE)	39.40	1,748	83.00	110.7
Swift Energy (SFY:NYSE)	35.44	877	60.00	69.3
Stone Energy (SGY:NYSE)	58.13	1,548	94.00	61.7
Spinnaker Exploration (SKE:NYSE)	42.25	1,207	44.00	4.1
Tom Brown (TMBR:NYSE)	34.63	1,384	36.00	4.0
Cross Timbers (XTO:NYSE)	28.86	2,384	36.00	24.7
Average**				77.3%
*Assumes 60% enterprise value/liquidation value premium implied by Shell bid for Barrett **Average change does not include Barrett Source: Banc of America Securities, Company Reports

He bases his analysis on Shell's bid premium over Barrett's preoffer enterprise value/liquidation value multiple. "The average gas-weighted E&P stock would need to climb more than 75% to achieve the 60% EV/LV premium implied by the Shell bid at $55/share," he wrote. There may be additional upside, as his liquidation values are based on oil prices at $21 per barrel and gas prices of only $2.65 per-million British Thermal Unit or mmBtu.

Fischer's data assume a static set of circumstances for other mergers. Many analysts acknowledge that Barrett is a company with high-quality, proven reserves and that other companies wouldn't fetch such a rich multiple. Yet, it does provide some benchmark to handicap future potential deals. "It is unlikely that most of the gas-weighted E&P stocks could achieve the Shell-bid valuation even in a take-out," notes Fischer. "[However], this analysis does highlight the wide valuation discrepancies in the group." Fischer's three favorite plays in the natural gas E&P business are Newfield Exploration (NFX:NYSE - news - boards) and Louis Dreyfus Natural Gas (LD:NYSE - news - boards) in the mid-caps, and Devon Energy (DVN:NYSE - news - boards) among the large-caps. He rates all three a buy and his firm has provided banking services for Louis Dreyfus.

While additional combinations may occur, other analysts don't think Shell's offer for Barrett is a sign of things to come and, even if it is, they wouldn't try to handicap the take-out candidates. "You want to play the North American Gas game, not the takeover game," says Simmon's Pickering. "Three out of five times you play the takeover game you place a losing bet."

That said, Pickering does think additional mergers involving majors may come to pass. "You get a meaningful, wholesale transaction from this deal," he says. "This is the most efficient way for the majors to get back into the North American natural gas business."

From the Rockies to the Gulf Coast

Simmons E&P analyst Mark Meyer says the Shell deal also provides insight into the trends that will drive valuations higher in the natural gas business.

Shell's selection of Barrett as a partner was well-calculated. It gives Shell access to rich natural gas reserves in the Powder River Basin in the Rockies. In addition, it gives Shell significant exposure to Barrett's rich coal bed methane fields that hold tremendous upside production potential.

"Companies are becoming increasingly interested in coal bed methane," says Meyer. He notes three additional coal bed methane plays may be in the sights of those looking to buy their way into rich gas assets. "Western Gas Resources (WGR:NYSE - news - boards) is a 50% joint venture partner with Barrett in the Powder River Basin. And, Devon in Powder River and Evergreen Resources (EVG:NYSE - news - boards) in the Raton Basin in Colorado have significant coal bed methane exposure." Meyer thinks Devon is more likely to be an acquirer of new assets rather than an acquisition target. Meyer does not officially follow the three companies mentioned.

He also thinks Shell's interest in the Rockies may develop as a trend for majors looking to rejoin the North American natural gas markets. "The quality of production is as good as you will find in North America," Meyer says. "And, you have a lot of upside potential, especially if you gain access to any off-limits acreage." He thinks interest will move from the Rockies to more conventional land plays -- the Kansas, Oklahoma and Texas regions -- on to the Gulf Coast and then, finally, to the Gulf of Mexico shelf, looking for major gas finds below 15,000 feet, much deeper than current Gulf Coast drilling.

Meyer suggests a focus on two companies that have years of proven reserves and strong growth prospects: Mitchell Energy (MND:NYSE - news - boards) and Louis Dreyfus Natural Gas. "Both are built around a centerpiece of solid drilling prospects," he says. "They are insulated from commodity price swings. They won't have to go out and buy their growth for years to come." He rates both Mitchell and Louis Dreyfus buy and Simmons has not provided banking services for either.

One other area to watch is Canada, a hotbed of deals well before Shell's interest in Barrett. E&P companies like Apache (APA:NYSE - news - boards), Anadarko (APC:NYSE - news - boards) and EOG Resources (EOG:NYSE - news - boards) have acquired Canadian gas interests. And, convergence plays like Calpine (CPN:NYSE - news - boards) and Mirant (MIR:NYSE - news - boards) have been building a Canadian presence. "You are seeing and will likely continue to see a number of Canadian plays," says Pickering.

So, listen to Cramer and buy. Just be focused. The long-talked-about de-coupling of natural gas and oil prices is likely to continue and that has created a market where gas trumps oil.