With winter on the doorstep, it's a good time to think about what will impact energy equities during the final 31 days of 2005. This year has been very good for energy investors, especially compared to most other sectors of the market. However, investing is all about what will happen in the future.
I won't attempt to predict the weather, but here's a quick list of factors that will likely dictate energy trading in the coming weeks:
Weather: As winter begins, there will be no bigger variable affecting commodity prices than the temperature outside your window. It has been an unseasonably warm fall, which has pressured commodity prices. However, when the mercury drops, it's usually a pretty good time to invest in energy. So, more than anything, watch the weather maps: The coming cold snap in the Northeast will likely provide support for energy.
Capital budget announcements: We are in the season where exploration and production companies will begin to announce their 2006 capital spending plans. With robust cash flows, expect budgets to move higher, which should be bullish for many companies. The more they spend, the more oil and gas they should find, which should boost earnings and cash flow outlooks.
Consolidation talk: As brokerage firms begin to issue their 2006 outlooks, there will likely be a lot of chatter about consolidation among exploration and energy service companies. Whether it actually happens is another issue, but the M&A speculation alone is likely to get some investors excited about the coming year.
History: As I've said before, December is typically a very good month for energy service stocks. Although the recent rally may have squeezed out some of the short-term juice, there will likely be a lot of funds that want to show they own these stocks at the end of the year. As a result, history is on the side of the bulls for energy stocks as we end the year.
Rotation: Depending on how technology, retail and financials are looking as we end the year, there is a chance rotation could put a bit of pressure on energy names. While I don't think energy is overowned, there is the perception that there will eventually be rotation out of the OSX, or oil services, and into the SOX, or semiconductors. I don't think this will happen in December, but it's something to keep on your radar.
Earnings revisions: December may be a bit early for earnings guidance revisions for most oil companies, but activity in the energy patch does suggest fourth-quarter earnings should again be strong. And, so far, there isn't a lot of anticipation that earnings will be much better than expected. Any upward revisions should help lift the stocks.
Of course, the big wild card is commodity prices. I believe oil and natural gas prices will moderate a bit into 2006, but winter isn't traditionally the season for weak commodity prices. As such, $50 oil and $9-$10 natural gas will likely be with us through the season. Although fluctuations in price will yield volatility in the stocks, weakness should yield opportunities through the winter months.
Consider this list an early holiday gift. December should be a pretty quiet month, but watch the factors outlined above for their impact on the energy group.