The difference between the haves and have-nots in the mutual-fund world over the past year or so often came down to a single question: How much of the portfolio was in energy stocks?

Oil, natural gas, coal -- all have enjoyed impressive rallies over the past two years, helping energy companies generate fat profits. As oil hovers above $70 a barrel, will investors make a mistake by shifting money into energy-focused mutual funds -- or sticking with the ones they own?

To get a sense of the sector, we turned to Dan Rice, who oversees one of the top mutual funds of the past decade, BlackRock Inc.'s BlackRock Global Resources Fund. Mr. Rice, 54 years old, has run the fund since its launch in 1990, when he was at State Street Research. It is No. 1 among energy funds for the past 10 years, up an average of more than 21 percent a year over the decade, more than double the broader market, according to fund tracker Lipper Inc. Those long-term results also place his fund on the top-10 list of all mutual funds. The portfolio, closed to new investors since January 2005, rose 56.8 percent in 2005.

It hasn't been a smooth ride over the years. The fund lost about 50 percent in 1998.

Mr. Rice also runs BlackRock All-Cap Global Resources Fund, which remains open to new investors, and manages about $2.5 billion for institutions. Here is our conversation:

WSJ: Why are you so bullish on energy stocks, after their big run-up?

Mr. Rice: I have no idea about the next month or two. But we look at models (showing how) these stocks have traded during the last 10 years (relative to cash flow). Energy-stock prices currently (assume) $45-a-barrel oil through 2012. That is what the market's long-term expectations are. And natural-gas stocks assume a long-term price of $6.25. But our expectation is that long-term oil prices will be at least $55 a barrel, on average, and around $7 for natural gas. We don't speculate on how long the market will take to get to these levels, but if we get there, the average oil stock can go up 40 percent-45 percent, with gas stocks going up 20 percent-25 percent.

Even though the stocks have been monsters, the market hasn't fully caught on.

WSJ: Why won't energy prices tumble as they did in the 1980s after the last spike?

Mr. Rice: The last price collapse was created not so much by lower gasoline and electricity use, which didn't really change. The key was (that) power plants began substituting cheaper ways of making energy, such as coal, nuclear power and natural gas, instead of crude oil and residual oil.

But today we've eaten through the surpluses of the early 1980s of coal, natural gas and nuclear power, and there's been little to no new investments in those areas. People are only now saying we need more coal and nuclear power, and environmental laws are stronger now for developing new sources of energy. ... This time around, we can't do that substitution.

WSJ: What would shake your bullish hypothesis?

Mr. Rice: The real worry I have is that oil prices go higher, and at some point you will induce significant demand destruction, and that is not good (for shares of oil producers).

But we haven't really seen that yet. We're seeing growth of gasoline consumption of between 1 percent and 1.5 percent a year in the U.S. While there usually is a lag (in consumers reacting to higher prices), and growth is indeed slowing even though the economy is strong, it really is amazing that consumption is up.

(At $70- or $75-a-barrel oil) and close to $3 per gallon (at the pump), I don't know what demand growth there will be, if any, and at $80 a barrel we probably will have some demand contractions. So, long term, I don't want to see that. I suspect that as oil prices go up and the short-term trading crowd gets more excited, I will become more and more negative. The difference between me and the bears is that I don't think at $60 a barrel we get demand destruction. It will more likely be between $80- and $90-a-barrel oil.

WSJ: Some bears argue that it has become more difficult -- and costly -- for energy producers to replace reserves, offsetting any gains from higher prices.

Mr. Rice: If oil goes to $80 a barrel and ... it costs $30 a barrel to find it and get it out of the ground instead of $20 today, that is still a $50-a-barrel margin, which is higher than margins are today.

WSJ: Are energy stocks more volatile than in the past given events in Iraq, Iran, Nigeria and Venezuela?

Mr. Rice: We have had sea changes that have brought extreme volatility, and we will continue to see it. Every year since 2000, we get two 20 percent wicked, severe corrections that shake out the weak hands among investors.

WSJ: Does terror-fear boost -- or reduce -- returns for oil stocks?

Mr. Rice: In general, anything that contracts world economies is not good for oil. Terrorism that shuts down supply could be a short-term positive; you could generate a price spike, but that is not a positive in the long term. You don't want to force the world to change technology and displace a lot of future oil consumption.

It's like we're driving down the road, and eventually we are going to fall off the cliff as we reach peak oil production in the world. We don't know if it will happen in three or 10 years, but we do know that the situation in Nigeria, Venezuela, Iraq and Iran could have a big impact on supply that shoves the car off the road at any point. It's a point that has to be factored in by investors. The best of all worlds for me is if oil sits around $60 or $70 a barrel until we fall off the cliff and peak oil is reached.

WSJ: So you think the peak could be hit in as few as three years? How would we know we're at the peak, and what do you mean by "fall off the cliff"?

Mr. Rice: The timing depends on when several of the world's largest oil fields begin to roll over. Unfortunately, information on most of these fields is guarded as a "state secret" and is difficult to obtain and analyze. Suffice to say that the average age of the Mideast fields in question (is) over 50 years old, and when they start to decline, the decline will be over 10 percent a year. That would be "peak oil," as the world probably couldn't add enough new production to offset declines of that magnitude from the giant fields.

However, I suspect that the price effect on oil would be somewhat muted by new coal-to-liquids production and additional liquid natural gas. As long as peak oil occurs post 2012, the world (would have) a chance to develop these alternative supply sources. If some of these fields start to decline prior to 2012, and the world hasn't developed the coal-to-liquids or LNG infrastructure, oil prices will rise substantially.

WSJ: There was a stretch in the late 1990s when your fund trailed the broader market. What was that period like?

Mr. Rice: It was very uncomfortable. Mutual-fund assets fell from between $500 million and $600 million to about $150 million during the second half of 1998. ... People took money out to buy technology stocks, creating the bubble. And falling energy demand from (the weakening economies of) the Asian Tigers, like Thailand, Korea and Philippines, took oil prices down hard. This came against a backdrop of increasing production from Venezuela, and it was exacerbated by a price war between Saudi Arabia and Venezuela. Most of the damage for us was in the last six months of 1998, when we got more and more bullish that a regime change in Venezuela would push prices higher.

We obviously were correct that Chavez would take office and there would be a rapprochement with Saudi Arabia and that prices would bottom out. Our analysis was correct, but our timing was off (because the stocks tumbled in the second half of the year). The price war ended in February 1999, and the stocks bottomed within a week. They've been screaming since 2000.

WSJ: What did you tell fund investors back then?

Mr. Rice: We saw the light at the end of the tunnel. But when you have those kinds of results, your credibility is strained. You can have all the persuasive arguments in the world, but there was a loss of confidence in the sector and shock of how low the stocks could go.

WSJ: How has it felt to bounce back?

Mr. Rice: I never got really depressed on the downs, and I don't get too excited on the upside. I'm not very emotional. You cannot be emotional in the oil business because there are so many ups and downs. Three quarters of exploration holes (that) the industry drills are dry, so you are trained not to be too disappointed or too elated. We felt prices could go up over the long term.

WSJ: How does that down period inform your investment approach now?

Mr. Rice: It injects a lot of humility because you can't control what will happen in the market over the next three to six months. You have to realize that the market can be very short-term oriented at times, and that doesn't mean you are a good or bad portfolio manager. ... I don't pay attention to anything short term. I don't even look at quarterly earnings. ... I know that is kind of weird.

WSJ: How do you find investment ideas?

Mr. Rice: We use a bevy of consultants, 20 to 30 consultants. We direct them (to dig up information). The macro analysis is 80 percent of it, and individual stock selection is 20 percent. In other areas, stock picking is everything. ... This sector is much more sensitive to the underlying commodity.

WSJ: Which subsectors still have promise, and which are coming off the boil?

Mr. Rice: We're pretty positive on every subsector, nothing is red flagged, and we are most bullish on coal. Coal has the most upside. Those shares are trading at the greatest discount to long-term prices, so we have as much as we can in coal shares like Consol (Energy Inc.) and Massey (Energy Co.). Those stocks can double. Oil producers like Occidental Petroleum (Corp.) or oil-service companies like Transocean (Inc.) have 40 to 50 percent upside. Natural-gas (shares have) the ability to go up 25 to 30 percent.

The only thing that would worry me is a (mutual-fund) portfolio full of natural-gas-oriented stocks. They're not as cheap as coal or other areas.

WSJ: How do alternative-energy stocks fit into the picture?

Mr. Rice: I have a tough time conceptually wanting to buy an alternative-energy company with a product that costs two to three times what coal costs to produce. You can build the cleanest coal plant with very low emissions and it will cost $55 per megawatt hour to produce, while a solar-power plant costs $220 per megawatt. I understand spending some money on solar energy, because oil might go away, but we have coal-to-liquid that is so much cheaper. It would take $200-a-barrel oil to make solar competitive without government subsidies.

Wind is cheaper. It is in the ballpark of oil in terms of cost, but there is no easy way to play that. General Electric Co. is the biggest company in the wind business, but it is just a small part of GE.

WSJ: How much should ordinary individual investors have in energy stocks and energy-focused mutual funds?

Mr. Rice: Between 5 percent and 10 percent of a portfolio. You would think it would be higher (given a rosy outlook for the sector), but the volatility in this area is so much higher than that with normal funds, and an investor typically can't stand that. We were saying it should be 15 percent in early 2000, (but shares have risen since then, and 5 percent to 10 percent) is still a healthy slice. My own portfolio is 90 percent, but most people can't take the volatility of a 20 percent drop in price.