Short-Term Bias Leads to Opportunities in Energy

Today’s Wall Street Journal presents a different side to yesterday’s bullish energy post:

“Weak Natural-Gas Prices Point to a Crude Awakening For Some”

The author, Geoffrey Rogow, points out the divergence between oil prices, which have rallied with natural gas prices lingering near decade lows. Using current surplus oil inventories as support, he reasons that oil prices may have gotten ahead of themselves. Without an economic recovery and a pickup in energy demand, any rally in oil is being driven by speculation. Some points are left unconsidered; for instance, the U.S. natural gas market is land-locked to a degree, hindering producers’ ability to maximize prices. But for the most part, these are all fine arguments and I can’t disagree with any of them.

But if the article’s premise is correct, then the recent rally in stocks is also unsustainable.

The gains in stocks have been driven largely by financials and tech. For both Rogow’s premise on oil to be correct and the current rally to be sustainable, we have to be moving to a state where people are making/moving money and upgrading technology while not producing or shipping more industrial goods.

How can there be a pickup in economic activity without a corresponding increase in energy utilization? By definition, energy is nothing more than the capacity to do work. Much of the decline in natural gas prices stems from reduced industrial demand. If the economy comes back and production increases, it’s hard to see how energy is left out. It’s only common sense but common sense can not tell us what markets will do in the short-term.

Happily, I don’t base my investment strategies on trying to predict short-term market moves. Common sense does not help with discerning whether the current rally is the dawn of a bull market but it can position us for the long-term. Even Wall Street is well aware of the pending supply issues in the energy space. Standard & Poors, in the March 25, 2009 Creditweek, stated “the long-term outlook for energy is undeniably strong”, even as they proceeded to warn on the oil servicers, European majors and Russian oil producers. Also consider this snippet from the March 13, 2009 Value Line:

Oil prices could go lower in the short term if the economy keeps giving off weak signals…However, it will be difficult for the industry to meet global petroleum requirements if long-term demand rises at a 1% growth rate…Given the downturn at hand, it will be like a few years before capacity is strained again.

As I’ve said before, the structural short-term bias built into the financial markets (see Seth Klarman’s Margin of Safety for a good breakdown as to why this exists) allows patient investors to buy,¬†at very attractive prices, solid energy stocks with the financial position to outlast this recession.

The key is patience but in these volatile markets, many investors can not see past the near term. For those inclined to look further down the road, this recent post may be a good place to start or perhaps my major integrated oils spreadsheet .

More on this topic (What's this?) Read more on Energy, Oil Prices at Wikinvest

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