As bullish as I am on gold, I’m more bullish on energy right now.
Sure, energy took a dive as the weather turned warmer. In my view, traders and investors alike shouldn’t worry so much about the winter we’re going through right now, but the summer coming up. It could be a doozy.
And it’s not like last year was a bad one for energy. Even with a three-month sell-off, crude oil ended the year 40% higher. Natural gas prices saw a year-over-year gain of nearly 83%.
Meanwhile, the Amex Oil Index (XOI) finished the year with a 36.8% gain. Compare that to the weak 3% rise in the S&P 500 … the 1.4% climb in the Nasdaq … or the 0.61% decline in the Dow Jones Industrials.
All in all, energy had a great 2005. Here’s what I see coming in 2006 …
First, the Bearish
News for Energy
Temperatures in the U.S. are running 21% warmer than the average for this time of year. This is bearish in the short term for heating oil and natural gas, because we need less of it to heat our homes.
On the other hand, that’s good news, because it gives investors a chance to buy energy stocks on the cheap.
Now for the
Bullish News
This warm winter isn’t a freak. The fact is, the world is warming up at a rapid pace. 2005 is the hottest year on record, going back thousands of years.
There was no one around to measure temperatures back then. But scientists can make a good guess by measuring the air in tiny bubbles trapped in Antarctic ice.
Now, I’m not going to argue about why the Earth is getting warmer. Some people get very defensive on this subject. The real question is: What does it mean for energy?
Well, it means that the natural hurricane cycle, which was on the upswing anyway, gets extra “oomph” from a warmer ocean. That means stronger and more frequent storms.
Three of the top five strongest hurricanes in history occurred last year, and Wilma was the strongest hurricane ever recorded in the Atlantic Basin.
2005 was also a record year for storms in a lot more ways: Most named storms (27) … most hurricanes (14) … most landfalls by major hurricanes (4) … costliest hurricane (Katrina).
In fact, a named storm actually formed this past Friday — Tropical Storm Zeta is spinning its way into the history books as I write this, long, long after the storm season should be over. Fortunately, it’s no threat to land.
But the next hurricane season should be a doozy for the oil and gas platforms in the Gulf of Mexico, which — so far — have seen 20% of the Gulf’s total yearly oil production and 15% of total yearly natural gas production knocked out by the storms.
If we’re lucky, all the damage from Katrina and Rita might be repaired by the end of March. And that means we’ll have just a few months reprieve before the Atlantic hurricane season starts again in June — a season that could see the oil and gas platforms in the Gulf of Mexico take another pounding, crimping an already-tight supply.
But there’s a more immediate crisis brewing in the energy sector … one with the potential to send natural gas prices soaring. And it could have a domino effect in crude oil as well …
The Russian Gambit
Russia’s natural gas monopoly, Gazprom, halted sales to Ukraine in a dispute over prices. Russian President Vladimir Putin said Saturday that Ukraine could continue paying the old, lower price of $50 per 1,000 cubic meters for the first quarter of 2006, but only if Ukraine agreed by the end of the day to start paying the new price of $230 in the second quarter of the year.
Ukraine said “nyet!”
There is so much to this dispute that I could write a book on it. Yes, Russia is punishing its political enemies — a Russian-backed candidate lost to Ukraine President Viktor Yushchenko (who favors better relations with the U.S.) in a highly charged election last year.
Ukraine says the price of gas is set in stone with a contract through 2009, so there’s nothing to talk about.
Russia, meanwhile, argues that the contract stipulates annual renegotiation of the prices. And the Russians are outraged that the Ukrainians are taking 15% of the gas that flows through their pipelines (80% of Russian gas exports to Western Europe pass through Ukraine) as a transport tariff.
Does this make your head spin? I haven’t even begun to scratch the surface of this geo-political convoluted mess that is like a blinking contest between madmen armed with matches on a continent soaked in gasoline. The important thing is, how does it affect us?
Well, with the fuming Russians cutting back on gas going through the pipelines, the Europeans are already feeling the pain. Natural gas prices in Europe soared 19% in the two days following the start of the dispute.
Western Europe relies on Gazprom for about one-fourth of its gas supplies. Most of this flows through the Ukrainian pipeline (there’s another pipeline through Belarus-Poland, but it’s maxed out). Russia provides 30% of Germany’s total gas supplies … 25% of Italy’s total gas supplies … 25% of France’s total gas supplies … 59% of Austria’s gas supplies. And unlike the U.S., Europe is having a cold winter.
Soon after Russia halted sales to Ukraine, the pipeline pressure began dropping. Supplies to Italy fell 24% in 24 hours. France saw its deliveries drop between 25% and 30%. According to a Bloomberg News story, “If Gazprom shuts down supplies to Ukraine for more than four days, the pipeline could lose pressure that will take weeks to rebuild.”
Where will the Europeans get their gas if Russia doesn’t come through? Out of the hands of U.S. consumers, that’s where …
The Other Dominoes
Are Now Set to Fall
European governments quickly told businesses to switch to alternate fuels. That means they’ll have to buy oil, and to do that, both governments and corporations may liquidate short-term cash reserves, which is often kept in U.S. Treasuries (European corporate purchases of U.S. Treasuries are up about 10% in the last year).
So, one of the side effects of Europe’s natural gas crisis could be a short-term destabilization of the U.S. Treasury market.
And make no mistake, the Europeans will buy natural gas out from under us. They’re already doing it. The U.S. is being outbid for imported natural gas so much that our Liquid Natural Gas facilities don’t work at anything near full capacity.
As the Wall Street Journal recently reported, a tanker carrying liquefied natural gas arrived from Nigeria and idled in the Gulf of Mexico for a week — during which prices soared in Europe — before sailing to Spain to unload its cargo.
Reason: The Spanish are willing to pay $2 to $3 per million BTUs above Gulf Coast spot prices. They aren’t alone. The British will pay a premium of $2 to $6.
How This Could
Hammer the U.S.
Consider the stats …
- The U.S. is 25% of the natural gas market world-wide.
- 52% of American homes are heated by natural gas. It’s been a mild winter so far, but …
- 42% of New England’s electricity is generated by natural gas-fired plants.
- 17% of the nation’s power is provided by natural gas- fired plants.
- In California, customers of PG&E are in for a shock. Their natural gas bills will go up by 43% in January. And electric rates will rise to a record high — above what they were during the 2000-01 energy crisis.
- The squeeze is only going to get worse. I’ve included a chart from the EIA of Electricity Generation by Fuel 1970-2020 (billion kilowatt hours). You can see that by 2020, the EIA expects we’ll be even more dependent on natural gas.
And this is BEFORE we feel any squeeze from the events unfolding in Europe. The latest news is that Russia has resumed normal flow in the Ukraine pipeline — for now — after its European customers howled in protest. But don’t for a minute think this is over. What Russia has done is shown the Ukraine and Western Europe just how dependent they are on Russian gas. Talks with the Ukraine continue, and if they don’t go Russia’s way, I expect the Kremlin to shut off the taps again!
Meanwhile, drilling rigs are in short supply … the major oil companies aren’t finding new big reserves and don’t feel any pressure to do so (after all, their profits go up with prices) … and OPEC members are noisily calling for a production cut.
Energy Prices Are
Ready for Lift-off!
I believe both oil and natural gas are ready to rocket, because, as I mentioned earlier, Europe will substitute crude products like fuel oil to replace natural gas. Let’s look at a chart of crude oil …
You can see how oil was trapped in a downtrend since September.
It pushed higher through that downtrend, then came down and tested it as support.
Now, oil appears ready to springboard higher.
So if you thought you missed the big rally in energy, don’t worry. The pullback we saw from September through December is giving you another great chance to get in at bargain prices, just in time for the long, hot summer.
There are many ways to play this next big move in energy. An easy way is to buy the Oil Service HOLDRs Trust (OIH) which tracks the large oil service companies or Energy Select Sector SPDR (XLE), which is a basket of stocks that tracks the energy sector.
Or you can always check out Martin’s old favorite, the Enerplus Resources Fund (ERF), a Canadian trust that yields a hefty 8.3%.
And in Red-Hot Canadian Small-Caps, we’ve already added one stock that could be a double in the coming rally and I’m adding another one this week.
Good luck and good trades!
Sean Brodrick
About MONEY AND MARKETS
MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Christine Johnston, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.
© 2006 by Weiss Research, Inc. All rights reserved.
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