Looking For the Next Sector to Boom? Try Energy

Now that the natural order of falling interest rates and rising stocks has (at least temporarily) been restored, it's tempting to just pick up where we left off in 1999 and jump back into the same old tech names.

But that would be fighting the last war. Instead, try following the money: Each cycle's biggest winners tend to come from industries where capital spending is rising. In the 1990s, that meant Internet infrastructure, but after Cisco's(CSCO Quote) inventory bombshell, it's hard to see this sector -- or B2B or telecom, for that matter -- leading the way anytime soon. There's simply too much bad news still to come.

A better bet is energy, where the supply/demand equation pretty much guarantees a string of great numbers. And within energy, a nearly certain capital magnet looks to be natural gas.

Last week I spoke to Bill Fries, managing director at Santa Fe-based Thornburg Investment Management, who's long the big oil and gas producers like Exxon Mobil(XOM Quote) and Unocal(UCL Quote). "The U.S. quit building conventional power plants 30 years ago," he says. "Coal polluted the air and everyone feared nuclear waste and meltdowns. Hydroelectric plants couldn't get past the environmentalists." In the meantime, our population has surged and energy use has risen almost as fast, leaving us with shortages that we're now trying to meet by building cleaner, more efficient gas-fired power plants.

"Today," says Fries, "we have an air-conditioned world driven by electricity that is powered by natural gas." As a result, the gas producers "should be one of the winning stock plays for investors over the foreseeable future."

So let's assume -- as is usually the case when a sector gets hot -- that natural gas is heading for a takeover binge. Recent history has plenty of instructive examples, but two that seem most applicable come from the 1980s, when junk bond raiders bid textile and railroad companies to loony-toon levels, and the late 90s, when Cisco and JDS Uniphase(JDSU Quote) paid whatever it took to get the most promising/threatening optical startups.

In both cases it was better to own the targets than the empire builders, because the latter eventually hurt themselves by overpaying for the former. And it was crucial to get out before the party ended (pull up a price chart for Corvis(CORV Quote) to see what happens if you overstay your welcome).

Assuming the pattern repeats, a good strategy would be to buy some solid little gas producers, and sell them into next year's frenzy. Most of these are Canadian, so I've spent the past few days looking for the ones likely to generate the most early takeover speculation. There are a lot, as it turns out, but here are three with U.S. exchange listings to get you started:

Gulf Canada Resources(GOU Quote) recently got some coverage as a takeover candidate in Martin Cej's CBS Marketwatch column. Its gas fields in Canada's Northwest Territories are huge and growing, and it has a big presence in Indonesia. It generated about C$1 billion in cash in 2000, twice the year-earlier number, while discovering about three times as much oil and gas as it produced. With a market cap of US$3 billion, it's an attractive but digestible meal for most of the major energy companies.

Canadian Natural Resources(CED Quote) generated cash flow of C$1.9 billion in 2000, about twice the year-earlier figure. Proven reserves grew by 32% in 2000, to the equivalent of 1.2 billion barrels of oil. That's about four times last year's production, and came at a cost of only C$6 per barrel of oil equivalent. According to company accountants, the net present value of these reserves is more than twice its US$3.5 billion market cap.

Talisman Energy(TLM Quote) has oil and gas fields in Canada, the North Sea and Indonesia, along with exploration projects in Algeria, Trinidad and Peru. Its reserves about doubled in 2000, making it Canada's biggest combined producer of oil and natural gas. This week it agreed to acquire Petromet Resources(PNTGF Quote), a company that I was all set to profile here. This deal gives a sense of what's coming: Petromet more than doubled in the couple of weeks leading up to the announcement. Talisman expects its natural gas production -- before Petromet -- to grow by 13% this year. With a market cap of US$5 billion, it's a little on the big side, but once the frenzy really gets going, $5 billion will seem like peanuts.