Cold Weather Could Heat Up Energy Space

As the weather gets colder, energy prices and energy equities may begin to heat up.

Crude's recent swoon is largely the result of three events. First, the weather has simply been too warm to generate any meaningful demand for distillates (heating oil), and that has pushed product inventories to abnormally high levels. Until we get more seasonal weather, which may be on its way, a crude rally will be difficult.

Second, the geopolitical premium has left the market. Most of the structural geopolitical issues remain, particularly in the Middle East, Nigeria, Venezuela and Russia, but they're in hibernation mode, and their impact on price is mostly gone. However, these issues will undoubtedly surface again sometime in 2007, potentially with a meaningful impact on crude prices.

Finally, OPEC's cohesiveness and its members' willingness to adhere to tighter production quotas remain suspect. Historically, OPEC has not been consistently good at enforcing quotas, and the bears argue that that will lead to a lack of supply discipline and too much oil coming into an already sloppy market as winter turns to spring. That said, OPEC seems much more inclined to stop any precipitous price slide now compared with past energy cycles.

Let It Snow

The first problem -- weather -- looks to be cooling down. Finally, temperatures in the Northeast have gotten chilly and look to stay that way in the coming weeks. Combined with unusually cold weather in the South, such as the ice and sleet in Houston and New Orleans, the increase in weather-related energy demand should be accelerating.

Some forecasts suggesting colder-than-normal weather into February could quickly reverse concerns over growing inventories of crude oil and heating oil. If that happens, crude prices should rally.

The key now is the $50 level. If prices hold $50 a barrel through next week, when the February Nymex contract gives way to March as the front-month contract, crude is likely to ruse. The natural psychological support at $50 is very important. If breached, the next support on the chart is at $45 to $47.

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At time of publication, Edmonds had no positions in any of the stocks mentioned in this column, although holdings can change at any time.

Christopher S. Edmonds is partner and managing director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.