Energy prices are notoriously volatile, but now they're moving in just one direction: up.
For a host of reasons, including strong demand, supply concerns, a lower dollar and the role of speculators, crude oil prices have skyrocketed--now topping $133 per barrel. Just a year ago, West Texas crude was costing around $65 per barrel.
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For investors, two questions need to be addressed. One, where does oil go from here? And two, where should stock market players put their money to capitalise on the action?
Forbes.com recently checked in with some market professionals to get answers. We asked these big-picture gurus where they thought the price of that black gold was headed. In addition, we wanted to find out how they're playing crude and where, exactly, they're investing in this runaway oil market.
One analyst with a lot of weight when it comes to oil predictions is Goldman Sachs oil analyst Arjun Murti. He's the analyst who predicted back in March 2005--when oil traded at around $50 a barrel--that the price would spike to $105 a barrel.
Now Murti thinks the price of oil could spike to $150 to $200 a barrel over the next six to 24 months. He says the core underlying drivers of the rise in oil prices remain firmly intact.
First, he writes, non-OPEC supply is struggling to grow, with notable declines being seen in Mexico, and Russia showing signs of rolling over following an extended period of rapid growth.
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"Rising industry cost structures and disappointing production growth and reserve replacement suggest non-OPEC supply trends are unlikely to improve," Murti says.
Second, OPEC spare capacity remains at very low levels, and OPEC countries are facing downward pressure on net exports due to lackluster supply growth and sharply rising internal demand, Murti says.
"Saudi Arabia is starting to acknowledge that while it can likely increase production in the near-term, production is not going to grow infinitely into the future."
Third, the analyst notes that key oil-exporting countries, for the most part, continue to restrict foreign investment, which will likely keep a lid on how fast supply can grow.
Finally, he points out that demand growth outside the Organization of Economic Cooperation and Demand remains healthy--due, in part, to economic growth but also, more meaningfully, to recent widespread power problems that have led to burning diesel and gas oil fuel in portable generators.
Murti's favourites include ConocoPhillips, Cabot Oil & Gas, Halliburton and Valero Energy. His favorite pipeline is El Paso Corp.
Dan Rice, the longtime portfolio manager of BlackRock Global Resources, a fund that invests in global energy and natural resources companies, also says that $200 per barrel seems within reason.
"Let's say we run out of coal," Rice says. "Or we don't have enough to satisfy electricity demand worldwide. We are already starting to have problems. Prices have gone higher, signaling problems with coal availability."
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So what happens if there isn't enough coal for the electricity providers?
"Two things happen," Rice says. "They burn more oil, in which case demand goes up, or you don't make the electricity, so you shut down industrial customers. You're screwed. Prices get to $200. That isn't pie in the sky thinking. It could happen. We haven't seen the tipping point yet. But most of the trends are in that direction."
Not everyone agrees that $200 is a done deal, however.
Longtime market pro Ed Yardeni thinks $200 oil is unlikely, since slowing economic activity around the globe means decreased demand for oil. Yardeni wrote in a recent note that it would take a fairly serious supply disruption triggered by a geopolitical crisis to drive prices up to $200 a barrel.
"Admittedly, there is one in the works as tensions mount between the US and Iran," Yardeni writes.
The questions for investors, though, are how to play oil and when is the right time to carve out some significant positions.
Curtis Hesler, editor of Professional Timing Service, sees oil moving to $160 by the end of the year.
"One restriction on this run could come from an opening of the strategic reserve to satiate demand temporarily and make things look good for the Republicans come election time," Hesler says. "Then perhaps we will see $160 after the typical lows next January--February. That will be another buying opportunity."
Hesler says it's difficult to recommend jumping in right now after a record run like we've experienced.
"I don't think the timing is right to buy now, but we will get some opportunities in the next several weeks if crude takes a pause here as expected," Hesler says.
He thinks that the only major to own is Apache.
"They are very good at squeezing oil from played-out fields. They also operate in relatively safe regions of the globe, and have an enviable history of maintaining and increasing reserves. This is something most other majors have not been able to do. What good is $160 oil if you have none to sell because your production has depleted?"
Hesler also likes the refiners as a more speculative play.
"Most of the new production coming online world wide is heavy sour crude, and most domestic refiners are not able to handle it," he says.
Frontier Oil and Valero, he argues, are exceptions and process heavy crude.
"The refiners are depressed right now because they have not been making a profit on gasoline due to complexities in the 'crack spread.' The crack spread refers to the value of product you get from a barrel of crude. However, gasoline has been rising and this will resolve this problem."
Over in Laguna Beach, Calif., Chris Armbruster of Al Frank Asset Management sees speculative froth in the market right now. But in the intermediate term--two to three years--he points out that the International Energy Agency sees a new demand of 37.5 million barrels per day but only 25mbpd planned capacity additions.
"So as long as the global economy continues to grow, supply and demand dynamics will at least keep prices elevated and probably force prices higher," Armbruster says.
Farther out, he thinks that high prices are creating demand destruction, and new supplies that used to be uneconomical, such as oil sands and shale oil, will provide solutions as well as alternatives, like nuclear, hydrogen, solar and wind.
Armbruster right now likes ConocoPhillips, which is cheap on a valuation basis. The reasons for low valuation include high debt level, refining exposure and 2 per cent long-term production growth forecast. But there are opportunities here, Armbruster says, including liquefied natural gas projects and investments in the Middle East and Asia.
He also likes Holly Corp, where refining assets are very valuable due to years of underinvestment, geographic limitations and construction complexity. The company boasts a geographically protected refinery in Salt Lake City with great margins. It's also building a pipeline to Vegas to create a huge opportunity to supply that market as well.
Finally, John Schloegel of All Star Investor offers up a few ideas.
First, he counsels investors to hedge oil with ProShares UltraShort Oil & Gas ETF.
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Schloegel says that the upside momentum in the energy sector is strong and now approaching the frothy stage.
"It is a great time to be holding positions in energy, but investors should be careful about initiating any new positions," he says.
Schloegel points out that there have only been two times in the past 20 years that the energy sector has had higher momentum as calculated by his shop's proprietary relative strength momentum indicator. Those two times were May 1999 and March 2005.
After the May 1999 momentum peak, the energy sector became volatile, experiencing -5 per cent to -7 per cent pullbacks in each of the subsequent four months before embarking on a more substantial -17 per cent correction. After the March 2005 peak, the energy sector immediately underwent a -14 per cent decline.
"A momentum peak does not signal the end of a bull market," Schloegel says. "However, it does suggest a high probability of a strong pullback or correction."
Schloegel also points out that the high price of oil forces money in alternatives. How to play that movement?
He likes Claymore/MAC Global Solar Energy Index ETF.
"This new offering from Claymore bills itself as the first solar [exchange-traded fund]," Schloegel says. "Global demand for alternative energy sources has risen in the past year. Solar sales are going through the roof. Why not protect yourself against $150 oil with TAN?"
He also likes American Superconductor, a wind and solar play.
Schloegel notes that the US Department of Energy estimates wind will generate 20 per cent of the nation's electricity by 2030. "Boone Pickens recently ordered 667 wind turbines for the Texas panhandle, as he expects to capitalise from this trend," Schloegel says. "Still, the market hasn't priced in these expectations into wind energy stocks."
Last year, American Superconductor generated 65 per cent of its sales in wind power energy. Schloegel says, "As they continue taking on more wind customers, they're also growing into the solar thermal space. This year they're partnering with Spain's Abengoa SA. The company will help connect Abangoa's Western US solar farms to the electrical grid. Moreover, 70 per cent of American Superconductor revenue is generated outside the US, so it's a globally diversified pick."
