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TWST: What are the elements within the energy industry of 2000 that have formed the basis for the industry’s performance in 2001?

Mr. Hyler: We continue to expect natural gas markets to remain tight due to rising demand and delays in bringing on significant new supply. The use of natural gas in electric power generation is expected to double over the next 10 years. Demand for natural gas (which has traditionally peaked during the winter heating season) will grow sharply during the summer electric peaking season. With summer demand rising, it will become increasingly difficult to inject gas into storage during the summer/fall for winter use. A sustained period of low gas storage should translate into higher gas prices and higher gas price volatility. Concurrently, with power reserve margins still tight in many regions and higher natural gas pricing increasingly setting electric price floors, we expect wholesale power prices to trend higher.

TWST: What does the ideal, integrated energy company look like today?

Mr. Hyler: There is no doubt that the market has begun to identify the benefits of integration from the wellhead to the power plant, including the ability to leverage physical assets through effective trading/marketing operations. The market has increasingly placed higher premiums (p/e multiples) on well integrated companies with the capability to maximize profitability along the entire Btu value chain. Interestingly, over the past year, with natural gas and power increasingly replacing oil as the primary growth engine in energy markets, the integrated major oil company has continued to lose ground (in the financial markets) to the integrated gas/power company. This trend is expected to continue as long-term growth rates for gas/power remain more robust than for crude oil.

TWST: Are there any manufacturing or infrastructure bottlenecks or scarcities that will have an impact over the next one to two years?

Mr. Hyler: Everyone talks about gas wellhead deliverability and the inability to find gas. That really only represents half the problem. We would also argue that the pipeline/storage infrastructure to effectively meet a sharp rise in natural gas consumption is just not in place. Gas demand in 2000 finally recovered back toward the 22 trillion cubic feet historical peak of 1973. Accordingly, one could argue that the infrastructure to move natural gas to consuming markets has largely been in place for past 28 years. The transition to a 28-30 Tcf market with dual winter and summer demand peaks will require tremendous investment in infrastructure. The same can be said for the electric power industry, where transmission bottlenecks have hindered the development of a truly competitive wholesale power market capable of wheeling low-cost power to power-short regions.

TWST: Let’s focus on a couple of the companies.

Mr. Hyler: El Paso Energy (NYSE:EPG) is probably one of our top names among the larger capitalized energy merchants. Quanta Services (NYSE:PWR), a company specializing in energy and telecommunications infrastructure, is a key beneficiary of the tremendous need to upgrade power and gas energy infrastructure. While the slowdown in the telecommunications space has hurt the company’s valuation, exposure to electric power grid upgrades, power plant tie-ins and natural gas-related infrastructure work suggest rising revenue streams. Moreover, with over 70 energy and utility companies now actively pursuing a telecommunications strategy, we expect increased long-term potential in telecommunications work from traditional energy customers.