Since March 2009, E&P companies (proxied by Amex Natural Gas Index, AMEX: ^XNG) have outperformed the broader energy sector (proxied by Energy Select SPDR, NYSEArca: XLE) by about 17%, according to Barclay Capital analysts Maneesh Deshpande, Venu Krishna and Kannan Venkateshwar. XLE is dominated by the integrated oil companies that are more dependent on crude prices while the E&P companies are also driven by natural gas prices. However, this outperformance of XNG is at odds with the analysts' weak outlook for gas prices and strong outlook for crude. "Using an average historical valuation of 6.0x forward-year cash flows and current stock prices, E&P names appear to be implying gas prices of $7.50 per million Btu, assuming $70 per barrel of crude, or $6.80 per million Btu assuming $80 per barrel of crude," they report. "In contrast, E&P analysts expect that gas will average $6.0 per million Btu in 2010." Meanwhile, Barclay's oil-equity analysts estimate that oil stocks presently discount a $70 per barrel at current levels. The oil equity analysts expect crude to cross $100 per barrel by 2011 or 2012. According to the analysts, "In order to express a view on the convergence between stocks exposed to natural gas and crude we recommend the following trade: Long a basket of integrated oil equities and short a basket of natural gas exposed E&P names in a 1:1 ratio."
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