When Andrew Lees isn't busy managing the Invesco Energy Fund, he can often be found tooling around in one of his three shiny, gas-guzzling muscle cars.

"I own two Mustangs and a Shelby Cobra, which probably average about 8 miles per gallon," says the 41-year-old Lees, who has managed the fund since 2008. "I love gasoline and I love driving. And it wouldn't be fitting for an energy fund manager to be driving around in a Prius."

This year's spike in oil prices following political unrest in the Middle East and North Africa has made it a bit more expensive to operate those vehicles than it was last year. That's just fine with Lees, who says he has plenty of room in his budget for the increase.

Many Americans, however, would probably welcome a respite from higher oil prices. That could happen if things play out as they did in 2008, when the price of oil plunged from $147 to $32 a barrel between June and December as the world sank into recession and demand plunged.

Lees says that with an economic recovery under way, a similar scenario this time around appears unlikely. Demand has firmed up considerably.

"Back then, when gas went over $4 a gallon, the reaction was to move closer to work and sell your truck," he says. "By now, people have already made those kinds of systematic changes to their lives. And they've realized they can't cram their families into a Prius." China and other emerging market countries, which account for some 60% of projected growth in demand this year, will also help stabilize prices over the long term.

For shareholders, pain at the pump has also meant better returns than the market averages recently. In the first two months of the year alone, the fund was up nearly 13%, compared to a 6% increase for the Standard & Poor's 500 index. Lees believes that certain sectors of the energy market are well-positioned to reap the rewards of higher prices, and that there is "room for 20% to 40% upside over the next 12-to-24-month period in some of our favorite names."

Short-term pullbacks in the price of oil and stock market stumbles could make the road to such returns bumpy, of course. But while oil prices may make headline news, Lees believes the fund should be viewed as a long-term bet on constrained supply and increased demand, as well as an effective portfolio diversifier.

"Long-term fundamentals remain compelling," he says. "Supplies lost from depletion must be replaced before new demand can be met. And as commodity prices declined, many major projects were put on hold, putting a further burden on future supply."
For now, though, consumers and investors are keeping their eyes trained on protests in the Middle East. Global markets largely yawned at the events in Yemen and Egypt earlier this year. But after the unrest in Libya in late February, the threat of contagion and supply disruptions became more real. ICE Brent Crude, considered by many as the best barometer of the global oil market, hit a high of $120 a barrel before easing back when Saudi Arabia increased its output. Following the spike, a number of analysts raised their oil price forecasts for the second quarter of 2011, with many projections coming in at over $100 a barrel.

While some observers see recent volatility as the product of short-term commodity speculators, Lees views it as a rational reaction to disruptive events in Libya, where oil production was slashed. "The oil price reaction to the unrest in the Middle East-North Africa region reinforces our thesis that global oil markets are actually tighter than conventional wisdom suggests," he says.

While the potential for disruption in oil-producing nations will continue to raise concerns about tightening supplies, a number of factors could help moderate prices. In Iran, for example, an overthrow of the theocracy could lead to more Western involvement in oil production, which would likely boost production. Saudi Arabia, where the royal family has a tighter hold on the country and where wealth disparities aren't as pronounced as they are in Libya, would likely continue to pick up some of the production slack if the flow of oil from less politically stable countries decreases.

As the drama unfolds among oil-producing countries, Lees continues to implement an investment strategy that concentrates on a focused portfolio of 30 to 50 stocks out of a universe of 300 energy industry names. Among the characteristics he looks for are strong free cash flow and earnings growth. While the fund's average holding trades at a slightly higher price-earnings ratio than those companies in its Morningstar peer group, its estimated long-term growth rate is almost double the peer group average.

For the most part, Lees has implemented the strategy successfully since he took over the fund nearly three years ago. But in a recent report, Morningstar analyst Rob Wherry notes that Lees' attempt to minimize damage from the fund's presence in BP backfired following the Gulf of Mexico oil spill disaster, when the manager's ill-timed sale and subsequent repurchase of the stock cost nearly a percentage point of return in 2010. But he made up for the lost ground in the second half after rising commodity prices and better economic times led him to load up on oil service firms such as Cameron International and Baker Hughes. The fund swung from a 17.3% loss at the end of June to a 16.6% gain by the end of the year.

"Lees still has some proving to do before the fund gets a full-throated recommendation," says Wherry. "But this offering shows some promise."

Lees admits that like many of his peers, he was blindsided by the magnitude of the Gulf disaster. Before it happened, he says, BP managers had assured him that they were putting a renewed focus on safety issues and procedures.

But he also sees an upside to the event. "Now, the technology and regulations to help stop these kinds of blowouts are in place," he says. "When you're drilling for oil through 7,000 feet of water, you can't say there will never be a problem again. But the chances of something like that happening are much lower now."

The disaster also means opportunity for companies such as fund holding Cameron International, which has a 40% share in the market for devices used on oil rigs that prevent blowouts. Another holding, National Oilwell Varco, is also a major presence in blowout prevention. Both companies should benefit from a new rig building cycle as well as the need for new products to meet environmental safety standards.

At 39% of assets, oil and gas equipment and services represents the fund's largest industry component. Lees likes the group, which includes Cameron International and National Oilwell Varco as well as Schlumberger and Weatherford, because higher commodity prices provide incentive for companies to spend money on equipment and services to get new projects online.

Lees is somewhat less enthusiastic about oil and gas exploration companies, which account for 27% of fund assets, since they tend to be capital intensive, particularly in expansion cycles. But he does like prospects for fund holding Anadarko, which has initiated successful drilling projects in Ghana as well as emerging U.S. onshore drilling plays in West Texas, Colorado and Wyoming.

Lees also likes the outlook for metallurgical and thermal coal producers, such as fund holding Peabody, which he calls "the coal industry's well-run version of Exxon." Demand for coal has been rising since it's the largest electricity-generating fuel source. At the same time, supplies have been constrained by a number of things, including rising costs and environmental concerns in China, heavy rains and flooding in Australia's coal-producing region and a stringent U.S. regulatory environment that reins in production.

At 15% of assets, integrated oil and gas represent a significant underweight position relative to the benchmark Dow Jones U.S. Oil & Gas Index, which has more than 47% of its holdings in major integrated oil and gas service stocks. Although the stocks are relatively inexpensive, they don't have the growth characteristics Lees likes to see.

The fund is also underweight relative to the benchmark in gas exploration and production companies, which have been hit by abundant supplies and low prices. But at the beginning of this year he added to some positions in Southwestern Energy and Petrohawk, both leading explorers and producers of natural gas in the U.S., after gas prices finally began creeping up.

"There's a chance that the industry will become less awful than it was last year, although gas prices are still likely to remain fairly range bound," he says. "Things will get better in the second half of the year if producers stop drilling so much."