After reflecting on the big themes of 2010, here are a few that I came up with:
- BP's (NYSE: BP) Macondo oil spill and its fallout.
- The ongoing natural gas glut, courtesy of the Haynesville and other booming shale plays.
- The mad dash by independent E&Ps to get oily, and the rise of the Eagle Ford, Niobrara, and other liquids-rich plays.
- The return of the oil sands, including this giant IPO.
- Insatiable foreign demand firing the long-term supercycle for coal.
- Optimism giving way to frustration regarding America's nuclear renaissance.
- A stronger-than-expected year for solar, overshadowed by concerns over weakness ahead.
- A generally tepid turnout for other alternative energy businesses, including wind and geothermal.
Many of the above themes are interrelated. Weak natural gas prices encourage E&Ps to search for oil, and they also push down electricity prices. That hurts conventional power producers, but especially higher-cost renewable sources. As the head of Shaw Group pointed out recently, we're likely to see a lot more movement on nuclear power in places where natural gas runs $7 or $8 per million BTU, rather than the $4 or $5 that we've seen domestically for the better part of this year.
Defining events like the Macondo disaster are clearly impossible to predict, but that won't stop me from making a few wild prognostications about the year ahead.
Bold prediction No. 1: Oil goes higher until it doesn't
Oil has begun pushing against the upper end of its trading range in recent weeks, suggesting to many analysts that we're looking at a run back to triple-digit crude prices in the year ahead. Goldman Sachs analysts, for example, see $100 oil by the second half of the year, as global demand remains strong and OPEC spare capacity tightens. Once you add the magic of QE2 into the mix, that outcome seems entirely plausible.
As oil prices head skyward, investors will get increasingly confident and bid up the prices of speculative oil stocks, including those with no oil production. These same stocks will be most vulnerable to implosion when the music stops, so they're probably best avoided if you like to sleep soundly.
Bold prediction No. 2: Natural gas does not go to zero
Gas is trash today, but there are some reasons to believe we'll see some relief in the year ahead. Three-year leases originating in the land grab of 2008 will be satisfied, allowing producers to dial back on their drilling commitments in places like the Haynesville and Marcellus. Constraints in frac equipment, natural gas liquids processing, and pipeline capacity may keep a lid on activity in various plays. Hedge books will roll off, exposing producers to lower prices. The ongoing permitting purgatory will choke offshore supply growth.
I am not even going to attempt to time a rebound in natural gas prices back to the more comfy $6 level. Everyone that has done so has been wrong. I do want to increase my exposure to this sector, though. I offered up Contango Oil & Gas (AMEX: MCF) as an idea in late August, and may have missed the boat by not buying at the time. Southwestern Energy (NYSE: SWN), on the other hand, trades lower than when I tapped it as a low-risk bet. That business still looks like a good buy.
Something I will not do is invest in an indebted company that's not built to survive persistent weakness in the gas price. My friends over at Motley Fool CAPS are very bullish on Compton Petroleum, but even after the company's recapitalization, I'm just not comfortable with the financial picture. The operating leverage of less indebted producers should produce shareholder returns that are more than satisfactory.
Bold prediction No. 3: The world continues to rely heavily on coal
This one's simple enough. China and India, while simultaneously pursuing cleaner options in earnest, need coal to power their growing economies. They're looking to Australia, Mozambique, and elsewhere to get it. International companies like Peabody Energy (NYSE: BTU) will continue to benefit from this trend. I would probably favor export-oriented firms, despite the fact that the U.S. isn't kicking coal anytime soon, either.
Bold prediction No. 4: Alternative energy companies with poor fundamentals will continue to flame out
This year, we've seen Evergreen Solar (Nasdaq: ESLR) slump toward what looks like inevitable irrelevancy. Energy Conversion Devices (Nasdaq: ENER), whose thin-film laminates will face increased competition from Dow Chemical (NYSE: DOW) and other well-financed new entrants, probably isn't far behind. I'm all for green investment themes, but investors need to tread extremely carefully here. The sector is ripe for hype.
Well, that's as far as I'm willing to go with my predictions. If you're prepared to go further out on a limb, chime in with one of your own in the comments section.
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