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It's getting easier to separate the haves and the have-nots in the oil and gas sector.

Well, at least it was before the threat of regional war in the Middle East sent the share prices of just about all oil producers running higher, along with the price of a barrel of oil.

But once the region settles back down to its now unfortunately normal state of grinding small-scale slaughter, the basic trends in the industry will again come to the fore.

And you should be looking through the current disaster to own the long-term winners. It doesn't hurt that these same stocks should do well in the short term from financial markets' Middle East fears.

The have-nots are in a panic. These companies haven't been finding enough new oil and gas to replace what they pump. They're afraid of losing significant portions of their existing reserves to political upheaval in unstable regions -- if they haven't lost them already. And their portfolios of new projects don't promise to add enough reserves to make up for the shortfall. They'll pay almost any price to acquire more oil and gas.

The haves are sitting on their hands. They've been able to replace what they've pumped, and more, in recent years. The bulk of their existing reserves are in relatively stable regions. And most importantly, they've been successful enough at exploration and development to line up a portfolio of new projects that promise to keep production growing over the next decade.

If everything works out as they plan, the have-nots will survive and even profit from their current strategies of desperation. But the risk is high -- oil and gas profits in the near and long term have to be "just right." If not, some of these have-nots will wind up selling assets, if not their entire companies, at fire-sale prices.

The Strategy of Doing Nothing

Who will be there with armfuls of cash if that happens? The oil companies that have the luxury of doing nothing right now -- except count the cash as it comes flooding in. These companies' do-nothing strategies are, in fact, a bet that some of today's aggressive dealmakers will blow up, leaving the companies that have hoarded their cash to pick up the pieces at 50 cents on the dollar.

Guess which group of oil and gas stocks I think smart investors should be buying now?

Desperation was on full display last week when

Repsol YPF


, the Spanish energy company, bought


(BP) - Get Free Report

stake in the Shenzi field in the Gulf of Mexico for $2.15 billion. According to oil industry analysts at Wood Mackenzie, this price values the oil and gas that BP estimated it could recover from the field at a stunning $97 a barrel of oil equivalent. Repsol has said that it believes it can add enough extra reserves once it finishes drilling to cut the price to about $68 a barrel.

Spending $97 a barrel to acquire oil that's still in the sea floor underneath 4,300 feet of water in the hurricane-prone Gulf of Mexico? (By the way, it will cost about $4.4 billion to develop the field over the next nine years.) That's either extraordinarily bullish or just plain desperate.

After looking at Repsol's reserve numbers, I'd vote for desperate. In January 2006, Repsol revised its proved reserves downward by 25%, thanks to legal, political and technical changes in Bolivia (the source of 52% of the downward revision), Argentina and Brazil. That brings Repsol's three-year organic reserve replacement rate to a negative 95%, according to Standard & Poor's.

Exxon Mobil: Right or Missing the Boat?

Contrast that to what passes for big moves at

Exxon Mobil

(XOM) - Get Free Report

. In the first quarter of 2006, Exxon Mobil paid out $2 billion in dividends and spent another $5 billion on buying back its shares. For the second quarter, it upped its share repurchases to $6 billion.

With cash flow from operations of $14.6 billion in the first quarter of 2006, Exxon Mobil has been raked over the coals by some on Wall Street for not doing more with its cash. Even after those buybacks and dividends, the company closed its first quarter of 2006 with $32 billion in cash and cash equivalents on hand.

Exxon Mobil's reply boils down to "Why should we?" It's not as if the company isn't spending anything on capital projects and exploration. That part of the budget climbed to $4.8 billion in the first quarter, up 41% from the first quarter of 2005. And the company isn't hurting for either current or future production. The company has been able to both increase oil and gas production -- up about 7% in the first quarter of 2006 from the first quarter of 2005 -- and add to reserves faster than it pumps oil and gas. From 2003 to 2005, Exxon Mobil replaced 108% of reserves, according to Standard & Poor's.

The company is on record saying that it doesn't think current high oil prices will last -- and that it doesn't see the point of buying reserves or spending capital on risky exploration projects at current prices. (On the other hand, the company has been perfectly willing to spend money on relatively low-risk liquefied natural gas projects. On July 10, for example, the company announced plans to spend $3 billion on the second phase of its liquefied natural gas project in Qatar. First production is scheduled for 2009).

Rich Will Get Richer

I've written in the past that I think Exxon Mobil is wrong on future oil and gas prices, and I still think the company is wrong. But increasingly, that doesn't matter. Exxon Mobil and other cash- and reserve-rich oil companies are in a great position to pick up even more assets and at cheaper prices when oil and gas companies that have aggressively bet on higher prices hit the wall. The rich, as so often happens in this world, will get richer.

Why should any oil and gas production companies hit the wall, even if oil prices aren't headed significantly lower any time soon?

First, because shortages of everything from oil field workers to drilling platforms are pushing up costs and delaying production schedules in all the world's energy fields. That's an especially big problem for any company that is betting on getting big projects up and running on budget and on time.

Second, because loading up on debt to pay for acquiring oil and gas assets at high prices or to build big-ticket capital projects increases the risk that something will go wrong.

Watch Canada's Oil Sands

Oil prices don't have to go down for some of these companies to wind up in trouble. All that needs to happen is for cash flow to be smaller than expected and arrive later than projected. That's especially dangerous in a world where the cost of capital is gradually climbing as the world's central banks all ratchet interest rates higher (and as world stock markets remain in a funk).

Canada's oil sands are a likely hot spot for the first kind of trouble. Thanks to rising costs, some projects look like they will come in at as much as 50% over budget. And shortages of key personnel and equipment -- even at massively higher prices -- have pushed back completion dates for some projects more than a year. That wouldn't be a problem if a glut of heavy oil weren't squeezing these producers from the other side, too.

Hot spots for the second kind of trouble are likely to be scattered across the oil patch. What's needed to put the squeeze on any specific oil company is 1) an acquisition at inflated prices that 2) piled debt on an already stressed balance sheet. Let me emphasize that overpaying without overleverage won't be enough to drive an oil company to hold an asset fire sale. So look for companies with high debt, big spending plans and relatively small current cash flows.

Companies that have pushed the envelope have, in effect, rolled the dice, and their fate at the table will depend on such unpredictable elements as hurricanes, politics from Bolivia to Nigeria, stalemate or all-out war in the Middle East and the speed with which new oil field technologies develop.

Look for Strong Hands

But I do know that, in the current environment, I'd like to own oil and gas companies that are dealing from a position of strength and that are in a position to pick up assets if some other company in the field should stumble. My very short list of companies in that position would include ExxonMobil and


(CVX) - Get Free Report


I'd certainly like to avoid oil companies that may be feeling desperate to add to reserves at any cost. I'd worry about BP, for example.

But as an investor, I'd also recognize that any desperation to acquire reserves works to the benefit of the shares of smaller companies that own reserves, especially reserves in highly desirable, politically predictable regions. In my energy portfolio, I'd look to balance my exposure to an Exxon Mobil with shares of some potential acquisition targets. A list might include

Devon Energy

(DVN) - Get Free Report


EOG Resources

(EOG) - Get Free Report


Quicksilver Resources



A final word on the implications of this situation for oil-service and oil-drilling stocks: I don't think rising prices are good for a sector when it leads potential customers to delay work or cancel projects. That's where I think we are right now with drilling and service stocks. The bottlenecks that have raised prices to historic highs in the present now look like they could be producing a softer market in 2007 and 2008, just when major new capacity is due to arrive for drilling companies.

At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: EOG Resources and Quicksilver Resources. He does not own short positions in any stock mentioned in this column.

Jim Jubak is senior markets editor for MSN Money. He is a former senior financial editor at Worth magazine and editor of Venture magazine. Jubak was a Bagehot Business Journalism Fellow at Columbia University and has written two books: "The Worth Guide to Electronic Investing" and "In the Image of the Brain: Breaking the Barrier Between the Human Mind and Intelligent Machines." As an investor, he says he believes the conventional wisdom is always wrong -- but that he will nonetheless go with the herd if he believes there's a profit to be made. He lives in New York. While Jubak cannot provide personalized investment advice or recommendations, he appreciates your feedback;

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