Cold Winter Ahead for Energy Prices

This column was originally published on RealMoney on Oct. 17 at 12:08 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

In late August, I predicted that the energy sector was on the brink of a six- to eight-week selloff.

In particular, I expected crude oil to drop into the $50s.

Though that target hasn't been reached yet, crude has been steadily grinding lower since after Hurricane Katrina.

In this column I'll revisit crude oil, heating oil, gasoline and natural gas to see if they're nearing a turning point or if selling pressure will continue through the fourth quarter.

There's been enormous variation in price action in the energy sector since the big storm.

While infrastructure damage hurt some corners of these markets, it created opportunities in others.

Massive volume triggered price extremes that may take years to unwind.

There's a lot at stake for energy consumers in the months ahead. Consider a suburban Denver resident who paid $200 a month for natural gas heating last winter.

That bill could rise to over $500 this winter.

And Denver winters can last a very long time.

Indeed, heating-related sticker shock may have a greater impact on the American psyche than $3 gasoline.

Given the increasingly fragile state of the economy, it could be the final factor that leads American consumers to snap their wallets shut, triggering the next recessionary cycle.

Consolidation in Gasoline

Unleaded gasoline has had a wilder ride than its fossil fuel cousins since the monster hurricane. There was a parabolic spike in price action from $1.80 to $2.50 when the storm hit. The market then reversed quickly, dropping to $1.75 at Friday's close. There has been a 50% retracement of the last rally leg that began in November 2003.

Parabolic rallies often produce highs that will not be challenged for months or years. I don't think it will turn out differently this time around. In other words, the multiyear rally in unleaded gasoline that started under 50 cents in 2001 is now over. But that doesn't mean we're heading back to cheap gas anytime soon.

This market is oversold after its recent collapse and should enter a long period of consolidation. I would look for a trading range that persists for at least one to two years. Given the structure of the initial decline off the highs, that range should be bounded by $1.50 at the lows and $1.90 at the highs.

Crude Oil Bullish in the Long Term

Everybody is interested in the price of crude oil these days. In fact, the public has gotten so involved in the underlying equities that most opportunities have been priced out of them. This crowd adoration should remind readers of the way we loved tech stocks at the turn of the millennium.

That said, crude oil shows a more bullish long-term pattern than unleaded gasoline. But the short-term damage may just be starting. Crude reversed at parallel channel resistance after Katrina, and it could reach the mid-$50s this winter, before starting a new rally that extends well into the spring of 2006.

This deeper plunge would shake out retail speculators and convince most people that crude will never see the lofty heights of $70 again. In turn, this negativity could start the rally of the century, catapulting oil to the magical $100 level.

Start of Something Big in Natural Gas

I was surprised that natural gas mounted multiyear resistance at $10 so easily last month. In retrospect, this breakout was an accident waiting to happen. The fall calendar draws in waves of natural gas speculators who take considerable bets on this etheric winter fuel. Combine this seasonal bias with the storm of the century, and resistance is futile.

A multiyear breakout marks the beginning of something big rather than its climax. This suggests that the best that consumers can hope for this winter is a pullback to support at $10. This scenario is very likely to unfold because of the unfilled gap at this level. Energy traders understand the pressure being applied to pull into this magnet price and won't stand in its way.

But that selloff could easily mark a low that natural gas won't see again for years. In fact, we could be watching nervously this time next year while natural gas makes an assault on $20 and above.

Heating Oil Hard to Read

Leave it to heating oil to be the odd bird in the energy complex. Its price action looks nothing like the other patterns reviewed in this column. Heating oil has been grinding through a sideways market for the last two months, swinging back and forth in a tight 30-cent range. It's almost impossible to tell whether this price action is bullish or bearish.

Right now, the pattern says to stand aside and wait until it makes up its mind. It also suggests we pay close attention to winter prognostications coming from AccuWeather and the National Weather Service. Any hint that the northeastern winter will be warmer or colder than previously forecast could rip heating oil out of this choppy action and into a sustained rally or selloff.

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