The first four trading days of 2016 have gone down in the record books as the worst start of any year… ever. The energy sector has hardly escaped the volatility; with downward moves like these there are few segments escaping the markets’ wrath.
Good thing we have a number of ways to make money regardless of where oil goes.
The broader energy space certainly keeps an eye on the movement of the price of oil. But increasingly that is no longer where the real action is.
You see, the “crunch” portrayed by some pundits as representing what oil is doing to the energy sector as a whole is not only overdone, it is also quite misleading.
First, here’s the truth…
Oil Doesn’t Drive the Energy Sector Anymore
While crude oil has moved down to levels not seen in more than a decade, those levels are now beginning to inch back. But with a market that continues reacting to concerns about oversupply, the Chinese economy, and rising tension in the Middle East as if it was actual pressure for higher production and lower prices, oil news continues to dominate the energy scene.Now, don’t get me wrong. We are not yet in a post-oil environment. However, the developing energy balance I have discussed here in Oil & Energy Investor on many occasions is no longer driven by only one energy source.
- That much is apparent, as even amid a “crunch” in oil prices, there are five bright spots in the energy sector, which hold great potential for investors…An Oversold Sector Means There Is Plenty of Upside
First off, any stabilization will result in significant upward action almost across the board, price rises that will be much larger than any general market recovery. Energy in particular remains a significantly oversold sector.
And as I have observed before, there remains a discernable component in the low price of oil that bears no relationship to the actual market. We continue to see a component of the downside move fueled by short and futures contract manipulation, not by the dynamics of the underlying commodity itself.
As of close yesterday, my algorithm to calculate the portion of price decline resulting from this artificial yo-yoing of oil stands at its widest point since I began running these figures almost two months ago – $13 in New York for the West Texas Intermediate (WTI) benchmark and $15 for Dated Brent set in London.
That still leaves us with a crude oil “fair value” of less than $50 a barrel. While that remains low, you need to keep an important consideration in mind. A rise in market price will require that this “soft” portion of the drive decline by unwinding and covering short plays. That merely increases the move up (and corresponding advances in share prices).
But remember, there is more to energy than just oil…
- Rising LNG Prices Present an Opportunity
Second, while natural gas has also exhibited weak prices, it is now rebounding as colder, more seasonal, winter weather kicks in. Henry Hub prices, the NYMEX daily contract price set at a confluence of pipelines in Louisiana, has risen 15.5% over the past month (4.2% over the past two sessions).
That also remains a low price by historical standards and natural gas is also adversely affected by a large surplus in production. Nonetheless, it is benefitting from a wider application of end user applications: replacement of coal in the generation of electricity; wider replacement of oil products as a feeder stock for petrochemical manufacturing; rising industrial usage; continued expansion as a transport fuel, especially in heavy trucking and municipal transport; and the advent of U.S. liquefied natural gas (LNG) exports.
Speaking of which, U.S. LNG exports are beginning now, with Cheniere Energy Inc. (NYSE MKT:LNG) initiating large 20-year contracts to both European and Asian customers. The low price of natural gas will temper this a bit at the outset, but Cheniere has pioneered a contract formula that guarantees a profit margin regardless of the transport costs – an impressive feat.
All of this means selected natural gas producers will be able to continue hedging prices forward. Any concerted rise in oil and gas prices, therefore, will allow the share value of these companies to rise as well.
Remember, we don’t need a rapid rise in commodity prices to make money off of a range of beaten up stocks. As the stabilization in both oil and gas hits, there are plays that will emerge in advance of a general improvement.
Selected midstream service providers will improve before the broader sector. Many of these have been beaten down much more than even oil and gas producers. That means the move up will be quicker and more pronounced.
And as the action is moving away from oil, for now, natural gas isn’t the only energy commodity that is seeing higher market activity…
- The Prospects in Alternative Fuels Are Growing – Fast
Third, and most importantly, the prospects in renewables, nuclear, and alternative fuels have been rising fast. Even in the current downturn a number of these companies are supporting double-digit gains.
I have previously written about the main reasons for this. Solar, wind, and biofuels have realized huge cost declines. With large infrastructure capital commitments now completed, and technical improvements applied, solar and wind have reached grid parity in many regions.
This means they are now as cheap (or in some cases cheaper) than traditional oil products, gas, or even coal.
Meanwhile, there is a veritable revolution underway in alternative fuel applications that have dramatically reduced costs to end users along with providing for the first time genuine competition in fuel sources. It is here that the further development of biofuels provides considerable promise (and profitability).
When it comes to nuclear, there is a shortage of fuel approaching. The increase worldwide in new nuclear power plant projects – led by Russian and Chinese construction, but also including a faster reopening of reactors in Japan than anticipated – will usher in some hefty upside for nuclear fuel producers. This one will have a massive upside moving forward.
And all this is happening against a backdrop of rapid advances in infrastructure…
- The Distribution of Energy Is Now as Important as its Sourcing
Fourth, increasing reliance on smart grids, attention to energy efficiency, and the need to network energy-saving approaches has provided another dimension to energy investment.
This is no longer just about where the energy is sourced.
It is becoming about how well and inexpensively that energy is distributed and utilized. This is all about making greater profits without having to increase the amount of energy consumed.
Finally, there is one element that continues to escape the notice of those pundits intent on driving down energy (often for a quick buck in a short play)…
- Energy Demand is Rising Across the Board
Remember, demand continue to increase for all types of energy.
This is playing out globally, and has already resulted in the setting of new records in both energy consumption and need.
It is important here not to take one’s measure from either North America or Western Europe.
The days of the OECD (i.e. the “developed” nations) setting demand levels has been over for some time. Demand levels are being fueled by other parts of the world, especially the broader Asian market (that is, not simply China).
That’s where the bulk of new and expanding demand is moving.
Here’s what all this means: 2016 is going to be one profitable year for energy investing regardless of what happens to the “traditional” sources of energy. And I’ll be right here to guide you.
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