Market Analysis

Energy Depletion?

The Energy sector has been one of the best stock performers over the last several years.

The Energy sector has been one of the best stock performers over the last several years. Yet, oil is down nearly 15% this year and the MSCI World Energy Index is also off about 7% in 2007. What gives?

We continue to believe the Energy sector is an attractive play for stock investors. Let's look at the issue from the perspective of good old supply and demand for oil, and how Energy companies stand to benefit:

Demand Set to Remain Strong

  • Oil and natural gas consumption are driven by global economic growth. Particularly with emerging countries like China and India coming online, world demand for energy should only grow in 2007. To wit, despite record nominal oil prices in mid-2006, oil demand growth in major consumer countries hasn't fallen at all! In fact, Chinese demand growth has been accelerating.
  • There are no good alternative substitutes for oil today. Sure, stuff like Hybrid cars and ethanol-based engines are developing, but it's years before either can make a true impact on the market. So we'll be burning predominantly oil for some time to come.

Supply Still Tight Relative to History

  • Though spare capacity of OPEC producers has risen a bit, global oil and natural gas production capacity remains fairly tight by historical standards. We've often said oil presents an "asymmetric risk" (see our past commentary "Asymmetric Investing"). That is, the possibility of supply disruptions is far greater than surprise production increases. This means the equilibrium price of oil is more likely to go up than down as it relates to supply. Persistent geopolitical concerns in Iran, Nigeria, Iraq, Venezuela and Russia North Korea and the Israel-Lebanon conflict continue to exacerbate fears of supply disruptions.
  • It's a distinct possibility OPEC will make further cuts in oil production to stem price declines—just today Saudi Arabia announced its cutting South Korean refiners supplies by between 11% and 14% in February. The same for Japan, China, and Taiwan.
    • "$53 a barrel for WTI is unacceptable,'' Mohamed al-Hamli, who is also the oil minister of the United Arab Emirates, said in a phone interview from Abu Dhabi. ``It's very difficult to have 100% compliance, but we need to make the cuts that we have agreed."

How Energy Stocks Benefit from Strong Demand and Tight Supply of Oil

  • Equipment and services companies should continue to benefit from significant upstream capital spending increases. International rig demand remains very strong. National Oil Companies—some for the first time ever—are competing with International Oil Companies to gain exploration rights throughout the world.
  • We also expect more consolidation in the Energy sector—which features some very attractive valuations as a group today.
  • Sentiment is far from euphoric right now. For the first time since the beginning of the energy bull market, some major forecasters are now underweight Energy.
    • Hedge fund managers and other large speculators last week lashed their bets on rising oil prices by 89%. Bets on rising prices outnumbered short-positions by 2,194 contracts on Jan. 2, the lowest since Nov. 13, according to Commodity Futures Trading Commission data.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.