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Winter's Chill May Warm Energy Stocks

With oil trading below $60 per barrel and natural gas working its way toward $10 per million BTUs, there is a lot of talk in the energy world about the prospects for energy equities.

The stocks have traded lower as commodities have lost ground. However, with winter approaching, there's a good chance energy demand will inch higher and, if history holds, patience may well be a virtue for energy investors.

A warmer-than-normal fall has certainly had an impact on energy prices. Even though hurricane damage has continued to limit Gulf of Mexico oil and gas production, there has been little need for it -- temperatures all across the eastern third of the U.S. have been well above normal. It will stay that way the next couple of days -- 60s and 70s up and down the East Coast.

Combine that with warm Atlantic and Pacific surface water temperatures and a Canadian snow pack that hasn't moved below the Northwest Territories and you get an outlook for early winter that isn't terribly encouraging for natural gas investors.

In fact, Thursday is likely to bring another seasonally large build in natural gas inventories, and based on the first couple of days of this week, you may even see a build when the Department of Energy reports natural gas inventories for the week of Thanksgiving. If so, look for natural gas prices to challenge the $11 -- if not $10 -- level.

That could put additional pressure on natural gas-related equities, at least in the short term. There is little question that names like Chesapeake Energy (CHK - Get Report) have reacted negatively to the selloff in natural gas. What is ironic is that on a net asset value basis, Chesapeake is now selling at a price that discounts natural gas to $5 per million BTUs.

While that may not stop Chesapeake, and other natural gas producers, from moving lower if gas prices continue to slide, its relative value should provide a good deal of confidence for longer-term value investors. (Disclosure: My firm has provided corporate finance services to Chesapeake in the past 12 months.)

Cooling Off and Heating Up

While the short term may not appear rosy for energy investors, history suggests we may not have to wait long before energy stocks begin to rally. While the past is not always prologue, bad Novembers have generally led to good Decembers.

Looking at energy service stocks -- as measured by the Philadelphia Oil Service Sector Index (OSX) -- back to 1997, my colleague Samir Chauhan identified a very consistent pattern: November is typically the worst month for energy service stocks, and December provides investors the best opportunities. The data are set forth in the table below: It shows an average monthly loss of 5% in November and an average gain of 8% in December. So far this November, the OSX has lost about 5% of its value.

Oil Service Stocks
The OSX has lost about 5% so far this month
Click here for larger image.
Source: Pritchard Capital Partners, LLC

Moreover, take a look at 2001, when winter got off to a very late start -- indicated by consistent builds in natural gas storage through all of November. Stocks were up 12% the next month. That suggests that once the cold weather really hits, it's hard not to get a little more bullish on energy stocks.

There still may be a week or two to go in the choppiness in energy commodities and energy stocks. But cold weather will come -- I promise -- and, when it does, history suggests December may warm the hearts of energy investors.
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. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. 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.

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