Energy Names Have Stored Power

With oil breaching $60 a barrel and natural gas trading well above $7 per thousand cubic feet (mcf), it's hard to imagine the climate for energy stocks getting any better than it is right now. In fact, many oil and gas stocks are trading near at least 52-week if not record highs and estimates for solid second-quarter earnings seem to have set the expectation bar at lofty levels.

Of course, these same comments were made a year ago when oil prices were at $40 a barrel and natural gas was closer to $5 per mcf. But even as stock prices have entered new territory, it's important to remember an important axiom of the market: It isn't where stocks have been that matters, it's where they are going.

With that in mind, the energy thesis remains bright for the second half as solid demand, strained supply and the need to continue to accelerate drilling activity will provide plenty of opportunities for energy companies in the second half of 2005.

Moderating but Strong

Regardless of their outlook, almost all energy analysts and investors have one thing in common. Very few, if any, have accurately predicted the meteoric rise in commodity prices in the first half of 2005. As my regular readers know, I have been among the most bullish on oil and natural gas prices for the past 12 to 18 months, and even I did not expect the rapid run in crude prices and the linked run in natural gas.

A number of events have pushed prices higher:

• Concerns over security in the Middle East.

• Production challenges in non-OPEC nations such as Norway and Mexico.

• The political fiasco in Russia.

• Weather has had a clear impact, including the lingering effects of last year's hurricanes and the threat this week from Cindy and Dennis.

However, the primary reason for the sustained lift in crude prices is tight supply and robust demand.

Clearly, the growth in China -- and, in part, India -- has driven global crude demand, which is steadily approaching 90 million barrels per day (mmbpd). Given that global, sustainable production capacity is somewhere in the 85 mmbpd range, price has moved higher in search of a new supply-demand equilibrium point. The volatility and upward pressure on prices is a classic economic sign of a new paradigm in pricing.