The Year Ahead in Energy

This column was originally published on RealMoney on Dec. 20 at 3:42 p.m. EST. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.

In light of robust oil and natural gas prices, many investors are hoping that 2007 will be another solid year for energy equities.

While 2006 has been a good year for many energy investors, it wasn't quite as strong as 2005. Moreover, there are growing concerns that oil and natural gas inventories are building and that an economic slowdown could curtail demand. Both could affect prices of commodities and energy stocks.

Despite those valid worries, the underlying fundamentals of the energy markets remain solid. Demand from developing countries such as China and India should keep growing for years to come, while supply challenges, combined with exogenous political variables, should support relatively strong commodity prices into the New Year.

Here's a look at a handful of themes that may emerge in 2007.

Supply Challenges

Although many pundits point to signs of high inventories, the global crude oil and North American natural gas markets are still near the long-term supply-demand equilibrium.

Moreover, fundamental supply challenges remain. On the oil front, the Saudis are still seeing declines in their legacy oil-production fields, and Mexico's prize Cantarell oil field has peaked and is declining quickly. While there have been some appealing deep-water discoveries, such as the one in the Gulf of Mexico made by Chevron (CVX Quote), meaningful production is years away and will cost hundreds of millions of dollars to develop.

While natural gas remains largely a regional market, its supply fundamentals are just as challenged as crude oil. Production decline rates in existing wells average about 30%, which means drilling must be done more quickly just to remain at break-even. A growing rig count could have little impact on overall production.

In addition, geopolitical risks -- such as instability in the Middle East, violence in Nigeria and political unrest in Venezuela -- have not substantially improved in the past 12 months. The potential still exists for price spikes due to political disruption in the coming year.