Energy Looks Good, Oil Looks Great

This year's dramatic price swings in the energy sector may have investors wondering more than ever about the long-term fundamentals of coal, natural gas, and oil. Based on analysis provided by a recent McKinsey and Co. research report, it looks to me like energy investors will do just fine in coming years. And those invested specifically in oil may do best of all.

Recession or not, energy demand will rise
Before we profile individual fossil fuels, let's take a look at the report's take on global energy demand in the next decade. I used an interactive table that accompanies the report to construct two energy demand scenarios, both of which incorporate specific parameters for the following economic and policy factors:

  1. The ultimate bottom in global GDP growth during the current recession
  2. Light vehicle fuel efficiency
  3. Electric vehicle market share
  4. Energy productivity

The two scenarios are presented below.

Global Energy Demand

Quadrillion BTUs in 2006

Quadrillion BTUs in 2010

Quadrillion BTUs in 2015

Quadrillion BTUs in 2020

% Change, 2006-2020

Low-Growth Scenario

463.9

466.3

476.4

499.9

7.8%

High-Growth Scenario

463.9

494.9

555.1

622.3

34.1%

Data from McKinsey and Co.

Clearly, energy demand will grow -- but at what rate? OK, fine, one might wonder, but can't renewables such as solar and wind meet the world's increased energy needs? Only in part. According to the Energy Information Agency's (EIA) latest outlook, by 2020, renewable sources will contribute an additional 26 quadrillion BTUs beyond 2006 levels -- strikingly short of the extra 158.4 quadrillion BTUs required in the above high-demand growth scenario, and 10 quadrillion BTUs shy of meeting the low-energy-demand growth number.

And that's not all. The low-energy-demand growth scenario I constructed involves extreme projections of global GDP bottoming at negative 10.8%, and electric vehicles capturing 50% of market share by 2020. I don't think either will happen.

So while cutting-edge companies such as First Solar (Nasdaq: FSLR  ) and SunPower (Nasdaq: SPWRA  ) should enjoy plenty of alternative-energy appeal, fundamentals for the old-fashioned sooty, slick, and gassy stuff appear no less solid.

Pick a hydrocarbon, but not just any hydrocarbon
Now that we've got the broad energy picture in focus, let's drill down on fuel types. The McKinsey report sums things up as follows: "Although the supply of coal and gas appears to be sufficient to prevent long-term price inflation for these fuels, growth in the supply of oil will slow markedly." In other words, based on possible supply constraints, oil has the best chance of seeing "long-term price inflation." That should be a boon to shareholders of exploration and production companies such as Denbury Resources (NYSE: DNR  ) , Apache (NYSE: APA  ) , and Petrobras (NYSE: PBR  ) .

When might supply issues materialize? Assuming "without further action to abate energy- demand growth," the report cautions that "spare capacity levels in the oil market could return to the low levels that we witnessed in 2007 as soon as 2010 to 2013, depending on the depth of the economic downturn." And although a severe downturn would temporarily sink oil prices, the McKinsey report sees an ultimate return to a strong market:

... these lower prices actually can lead to market tightness returning more quickly. Low prices will either increase demand or at least have a neutral impact, while they will have a negative impact on supply. Because of this, even in a longer and deeper [economic] downturn, market tightness is projected to return shortly after the end of the downturn in any scenario.

Should our current economic situation slip into a GDP abyss, the eventual oil price rebound could be even sharper than what we've seen in recent months, given that this petro-rally has occurred without the support of strong physical demand.

Slippery slope?
Should you ditch shares of coal titan Peabody Energy (NYSE: BTU  ) and natural gas player Range Resources (NYSE: RRC  ) in favor of all things oil? No way. I believe those are strong companies, and besides, even if you decide to overweight your energy exposure toward oil, it's important to maintain some diversification. There are caveats to the oil-trumps-coal-and-gas thesis.

First, while McKinsey sees supply growing slower than demand given $75 oil, its supply projections come in a few million barrels per day below those of the IEA, EIA, and OPEC. If McKinsey's relative pessimism is off-base, the oil market might be marked with fewer and less severe price spikes, potentially to the disappointment of investors.

Second, McKinsey maintains that policymakers could eventually reduce demand by 6 million to 11 million barrels per day through such "low- or no-cost levers" as subsidy removal and fuel efficiency standards.

Foolish takeaway
Personally, I won't be holding my breath on comprehensive policy advancements. Also, far from being the oil market's death knell, these events -- should they occur -- would merely bring supply and demand into balance. That would mean a more stable price, not a ban on oil-company profits.

For energy investors who've stayed on the sidelines, oil's multi-month ascent has been painful, and I'm reluctant to say that now is the best time to invest. On the other hand, in the context of the coming decade, $70 oil is probably still a bargain.

Grease up your portfolio with these reads:

Petroleo Brasileiro is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Mike Pienciak does not hold shares in any company mentioned. The Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 16, 2009, at 7:30 PM, plange01 wrote:

    with the US 6 months into a depression energy consumptiom and travel is way down.the recent rise in oil prices is just hedge(trash) fund speculation like last year.give them a lot of bad press and they will get scared back into their holes...

  • Report this Comment On June 17, 2009, at 12:23 AM, Nohjnogias wrote:

    Depression or no, folks continue to drive, especially when the price of oil slips. Hedgers and speculators bid on the price of oil, like it or not, to the level of value approximating market demand. Let's suppose oil slips to 35 per barrel (unlikely), driving will go way up as folks take the cheap alternative vacations in the auto. When that happens, up goes the price of gas. Peak oil is here and hedgers and speculators can't do anything about it but react to a scarce commodity.

  • Report this Comment On June 17, 2009, at 6:18 AM, Sleddawg63 wrote:

    $140 oil will return, certainly within Obama's presidency. How do you push a green alternative plan with oil on the cheap? Yeah I'm talking conspiracy!

    Every administration is well capable of rigging their own agenda.

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