Why are energy prices running? Resurgent worldwide growth is a factor. So are inflation fears.
But preeminent is the fact that energy is priced in dollars and the dollar is, as Danny Devito said in the movie “LA Confidential,” “on the night train to the big adios.” With just a brief look at a long term chart of the US Dollar Index it is easy to understand why energy took off last year when the dollar broke below multi-decade lows. And with the dollar headed to test and likely break those lows you can see why prices are headed higher again.
The dollar is declining because of unsustainable government and trade deficits, massive liquidity furnished by the Fed to fight the deflationary effects of the financial melt down last year, and the inability of policy makers to reverse these trends. Traders are buying commodity stocks with impunity, secure in the knowledge that the Fed and Treasury both believe defense of the dollar is impossible at the present time.
The strength in the sector is in the less diversified companies that simply explore and produce (E&P). This group is up over 20% with companies that have the bulk of their activity in the United States leading the way with an average gain of about 23%. The fully integrateds, that refine and market as well as E&P have seen somewhat lesser gains, generally under 20%, as have the “pick and shovel” companies that drill, service and make equipment for the industry. Therefore for the most part our focus will be on domestic E&P companies. Indeed, when oil and gas stocks were running last year the greatest advances came from this sub-sector.
On our sister blog we’ve previously run the continuous contract of domestic oil which we repeat here. Price has broken from a base that is capable of supporting a further advance.
But if we are going to focus on domestic producers then another chart is more appropriate for our needs, that of Natural Gas. Three of the largest companies in the space, Apache (APA), Anadarko (APC) and Occidental (OXY) are primarily involved in oil. But most of the other significant domestic E&P’s are natural gas plays.
Natural Gas is a much different beast than oil. It’s not easily transported so it’s a local commodity, requiring a pipeline network for delivery except in cases where it’s liquefied, which is still a nascent niche. The gas market is therefore a parochial one. An excess of supply in Montana cannot be easily delivered to a customer in Europe.
Because gas is the cleanest of fossil fuels it has become the most politically expedient choice for new electric utility plants. With demand expanding less than supply price had been in a long term uptrend. But that all changed with new “fracturing” technology which made gas in heretofore difficult to access shale far easier to bring to market. The result was a rash of new supply coming to market last year, a resulting glut, and a crashing of prices to multi-year lows as "The Great Recession" throttled demand. Many producers have shut in wells with price dropping below the cost of production. Even so, analysts expect gas to be in oversupply well into 2010.
But we think the recent price move in gas is for real, and as it’s a local product price advances might not be contained even with a dollar that doesn’t depreciate further. Gas prices often have seasonal moves higher that start in the fall and last into the new year. And we expect that the market will begin to price in the anticipated drying up of inventories as the economy continues to recover.
We plan to profile specific stocks but bear in mind that while commodities don’t always trade in lock step with the stock market, commodity related stocks often will. Therefore we would not initiate positions early in a correction. Rather these will be trading ideas for when the indices resume their uptrend.
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