Wall Street Could Use More Energized Investment

Can you recall a more volatile, emotional time in the stock market as the one that transpired this past summer? It began July 17, when the Dow reached a headline-grabbing 14,000 points. The dramatic "consumer confidence index" surged to nearly 112 points. Things looked so bright in July, hardly anyone had time to complain about pump prices, which helpfully dropped in the wake of a mild hurricane season.

Then came August. Heat waves strained energy grids while triple-digit plunges, led by Asian market sweeps and the subprime-mortgage mess, wiped away earlier gain. The confidence index fell to 105 points. But between the explanation of "market correction" and the outright doomsaying, one salient point was overlooked: The Dow was still in robust 13,000 territory. And oil prices did not tank along the way, staying north of $70 per barrel all summer long.

Energy provides the heat, motion and feedstock that cause all economic action. Energy is the industrial oxygen that gives life to the economy. Currently the majority of that industrial oxygen comes from the various forms of hydrocarbons, and investment in hydrocarbons looks bright for the foreseeable future. In the United States, 50 percent of electricity comes from coal and roughly another 30 percent comes from natural gas. Of course, nearly 100 percent of U.S. transportation fuels come from hydrocarbons, and demand has risen for the last 200 years. Since supply is constrained and demand continues to rise, this can only lead to continued good times for investors.

"Energy is in all the sectors you may already be invested in anyway," analyst Mark Bernard told Oil & Gas Investor. "If you're in the S&P 500, you're in energy. If you don't think so, you're misled."

Those who are not misled include a bevy of investors who this year "poured some $1.6 billion into energy mutual and exchange-trade funds," the Associated Press reported.

But with investment comes risk, and for many that risk is still too high. Thus many investors are missing out on a growth market that will just keep growing. Ann Davis of the Wall Street Journal tried to put it into perspective: "Investors have been fleeing risky investments, but that doesn't mean oil futures will tank along with other ailing assets."

"Though market turmoil may accentuate a seasonal drop in crude prices this fall," noted the Associated Press Financial Wire, "other forces could pull oil back up in the short term or by year's end." When in late July an 8 percent drop in light, sweet crude brought the per-barrel price down from a record close of $78.21, Adam Robinson of Lehman Brothers Holdings attributed the downdraft "to hedge funds and other investors' attempts to raise cash from well-performing investments as they managed problems in other parts of their portfolios," as the Associated Press put it.

Even the bounce and plunge of late-July oil prices don't mitigate the fact that fossil fuels have held their double-digit percentage gains this year. So what accounts for the cold feet? You can always point to OPEC activity. The Organization of the Petroleum Exporting Countries will meet this month in Vienna, and analysts are already predicting that the member nations will vote not to boost production, particularly to satisfy U.S. desire for cheaper crude.

Hurricane season is also a big question mark for Wall Street. Hurricane Dean's August sweep through Mexico and threat to the U.S. Gulf prompted preemptive evacuations of some platforms. "It takes days to close down platforms safely and additional time to restart the facilities," the Associated Press pointed out. But even in the wake of a mild season, energy markets "are looking ahead to the seasonal softness in demand and fears that a slowing economy might make demand for energy softer than usual," according to analyst Phil Flynn of Alaron Trading Corp.

"As for finding new oil to relieve a tight market," noted Davis, "Western energy companies may pull back on exploration amid the current credit crunch. If this weren't enough, structural changes in the oil-futures markets [in August] lowered incentives to keep oil in storage."

Natural Gas
On the heels of oil profit come the spiking prices of natural gas. In its traditional form, gas is hitting a peak of $5 per million Btu, so the buzz is turning to investment in liquefied natural gas (LNG). "It's one of the biggest investment trends in the world," said David Talbot of the John H. Herald energy research firm. "That's what's happening," Talbot told CNN.com. "We're going increasingly from crude oil to natural gas."

In the same article, analyst Sheraz Mian of Zacks Investment Research wondered: "Will natural gas prices remain high enough for [LNG-related] projects to earn the returns investors are looking for?"

Interestingly enough, in the United States the majority of the drilling for natural gas is done by independents, and many of them are redeveloping fields that were bypassed by the majors years ago. These fields, which are very small by the standards set by Chevron and BP, are ideal investment opportunities for the independent oil and gas companies with experienced management teams. Investors would do well to focus on such companies.

Based on current production levels, oil reserves will last another 41 years, and gas reserves will last another 65 years. "That is, of course, if supplies remain uninterrupted in the Middle East and Russia, which produce 68 percent of the world's oil and 67 percent of the world's gas," qualified Larry Fein of the Investment U Research Team in a company report. "Coal supplies, on the other hand, are a much different story."

Coal reserves currently total more than a trillion tons worldwide, which, according to Investment U, could last nearly 155 years. In the United States, according to Fein, "there's roughly 267 billion tons of recoverable coal - enough to fuel the country's energy demands for 240 years." What's more, the biggest reserves are in the United States, which along with China accounts for more than 50 percent of coal production and consumption.

The prices of natural gas aren't hurting coal investment. "What you're seeing in coal stocks is overall strength," analyst Ann Kohler told the Houston Chronicle. "The higher natural gas goes, the more it favors coal."

But coal has its downsides. Most notable is the pollution caused by its production with aged, inefficient technology. A close second is the considerable public relations problem associated with coal-mining disasters that seem to plague the United States.

Recently Bob Murray, the head of Murray Energy, dealt with this type of crisis personally amid the tragedy that took the lives of nine men at Crandall Canyon mine in Utah (see Spotlight on North America, p. 6). Murray, unlike many others in management, used to work down in the mines and understands firsthand the conditions the miners endure; to his credit, he has a solid reputation that was built in the trenches. But even the most experienced in the coal game can run into problems of the most gut-wrenching kind when demand for the commodity runs high. In his 2007 article "Straight Talk about Today's U.S. Coal Industry" for our sister publication, World Energy magazine (Vol. 10, No. 1), Murray addressed many of these risks from his personal perspective.

Renewables and Alternatives
The United States is still the most attractive location for renewables from an investment standpoint, Ernst & Young reported in August. In its "Renewables Energy Alternative Index," the country led in attraction, followed by India, Spain and the United Kingdom. The U.S. attraction, according to Ernst & Young, can be attributed to the likely approval of a four-year extension of the federal production tax credit through 2012. Global investment could grow to $750 billion in the next 10 years.

Still, a number of short-term roadblocks are turning investors away from nontraditional energy sources.

  • Renewables may be an attractive target for investors, but from hydro to biofuels, no renewable has yet captured widespread acceptance. Solar panels are still a novelty, and you won't see flocks of wind farms in this country anytime soon either.
  • The new generation of clean diesel is still under the radar of automakers and drivers alike. Ironically, Detroit is on a quality roll (see article, p. 9), so why not encourage the Big Three to bring their diesel fleets up to speed?
  • Nuclear? Accessible, affordable and safe - but oh, so scary.
  • Coal-to-liquid and gas-to-liquid processes take considerable dollars for infrastructure and technology, and the payoff comes in the long term, not the short. "And there are risks involved with converting coal to liquid, especially in China," notes Investment U. "Coal liquefaction uses a lot of water, and many regions of China are already experiencing a critical water shortage."
  • And then there's corn-based ethanol. Any regular reader of World Energy Monthly Review will know where we stand on this overly expensive, underperforming "alternative."

One point looks certain: We are not moving from traditional energy sources for the short term. Right now, there is simply no alternative that meets the growing demand of the United States. Of course, decades from now we may be fueling our cars with beer cans and celery stalks, but for short-term growth, the smart money remains invested in hydrocarbon. "Just recognize that for the next few decades at least, oil, gas and coal will be by far the primary resources for global economic growth," said Kiplinger's James K. Glassman.

On the other hand, if you are young enough (and optimistic enough) to see the way forward for renewables, this is a good time to get in on the ground floor. But whatever energy market you choose, all signs point to "buy."

Why High Prices Are Here to Stay
With crude and natural gas trading at record highs, the resulting pump prices are inspiring some to compare the current market with the oil crises of the early 1970s. But there is a fundamental difference between 1973 and, say, 2003. Back in the 1970s, the United States was the market for oil. Thirty years later, a booming global marketplace has made China and India our chief rivals for imports.

With demand growing from emerging Asian economies at the rate of 10 percent growth year over year, what does the future hold for U.S. "cheap oil"? Increasingly, it appears that we will be competing for the attention of oil producers - in Iran, Venezuela and the Middle East - who would rather see their product go anywhere but America. Add to that the fact that 51 percent of the acquisition and development deals for energy were done in the United States, and that global companies were jockeying for the 5 percent of the world reserves the U.S. market represents, and you begin to see a real untold story. That is, at the same time the United States does nothing to defend its sources of cheap energy, it is even allowing other countries to come into its own market and buy up its already limited supplies. This is a great story for independents, because it guarantees that prices will stay inflated regardless of market demand. Sadly, it also represents more short-sighted politics-as-usual, courtesy of the U.S. government's energy policymakers.

Bottom Line
Energy fuels the global economy, and the investment opportunities that fuel major markets are relatively few. Anyone who follows the press would be more inclined to invest in renewable or alternative energy sources. However, with the thirst for hydrocarbons rising all over the world, it is very hard to ignore the fundamentals that investing in this form of energy brings to the surface.

Looking around the planet, it is easy to see the struggle caused by terrorism or unstable governments. However, one cannot deny that the U.S. economy is growing, as are those of China and India. The United States may have some strange political games at play today, but it is the most stable country on the planet and it affords the largest market for hydrocarbons. The opportunities for investment in an ever-rising, demand-driven commodity are available and relatively secure. So why would the Wall Street crowd shrink from helping to provide the energy the country desperately needs? Perhaps, like our government, the financial community needs to gain a clear understanding of what it will take to keep this country moving and to realize that we have the will to keep moving in the right direction provided the appropriate fuel and foresight is in place. Whatever the reason for hesitation by the general markets, financial opportunities for those who provide the energy for this economy are abundant.

As seen in World Energy Source, www.worldenergysource.com