The energy sector has been on fire in recent months. Companies once written off as bankruptcy candidates have seen their valuations soar into the stratosphere, but be cautious. The sector may yet have a tough row to hoe.
In the immediate aftermath of the Enron disaster, investors wanted nothing to do with the energy sector. Many even began listening for death rattles from firms like Dynegy
Such caution had its place. Early contrarians were swallowed up as many of these stocks sank to pennies per share. As is often the case, however, the fear and loathing of the masses created opportunity for those investors willing to participate in this high-stakes game.
Now that the sector has redeemed itself, are things getting a little overheated? I wouldn't go that far, but much as the talk of the "power glut" was overstated, the potential for long-term weakness in demand may now be understated.
Don't get me wrong, a believer in this turnaround, I'm pleased with the gains in these stocks, and I think selective opportunities remain. But the keyword is selective. Likely, you'll have to be quite the cherry picker to pass through this sector unscathed.
For one thing, demand for power is going to differ significantly from one region of the country to another. Where a company has the majority of its operations will be more important than ever in determining its profit potential in the years to come.
With that said, the darkest days may indeed be behind the most troubled players in this sector. Successful refinancings have finally given the energy merchants room to breath beneath their heavy debt loads. And Calpine's announcement today that, in the face of strong demand, it is nearly doubling its junk-bond offering (from a proposed $1.8 billion to $3 billion) is a sign that credit markets are again open to these companies.
All of this bodes well for the sector in the short term, but again, demand is key. Watch out if the expected economic recovery doesn't materialize in the second half of the year.
Bottom line: There are high-risk/high-reward opportunities in this sector, and there will be more. But if you find yourself itching to take a stroll down the high wire, make sure you choose wisely.
Mathew Emmert has beneficial interest in Calpine.