Big Dilemma for Big Oil

Crack spreads for petroleum products have risen from their 52-week lows in August, and energy stocks followed them upward through most of the fall. But oil stocks took a dive in mid-October and have yet to recover fully. The cause? The subprime mortgage mess, and worries about an economic crisis.

According to Brian Hicks, co-manager for U.S. Global Investors' (PSPFX Quote)Global Resources Fund, oil stocks, as represented by the Amex Oil Index, are no longer running parallel to commodity prices or to refining margins but are instead following the broader stock indices like the S&P 500.

"As goes the economy, goes the demand for crude oil," Hicks says. And the greater the demand for crude oil, the better that companies in the energy sector will perform.

The pattern was reinforced on Dec. 11, the day that the Federal Reserve met to decide whether to adjust its benchmark lending rate. The market was hoping for a 50-basis-point reduction, which would inject liquidity into the market and reduce the likelihood of recession, but the Fed only cut by 25. Upon the announcement, the Amex Oil Index immediately lost almost 2% in value, moving in tandem with Hicks' interpretation.

Heading into 2008, market participants will continue to focus on the strength of the U.S. economy and the potential ramifications it may have for the global demand for oil, Hicks says.

Alternative Solutions

If $99-a-barrel oil is one thing that 2007 will be known for, the arrival of renewable fuels and green technology as essential components of the energy mix is another.

Dan Pullman, principal at McNamee Lawrence & Co., says that a year ago he was educating people about the basics of solar power, biofuels and wind energy. "Now, conferences on this stuff are being held every week, and everybody is suddenly an expert," he says.

The interest in some type of renewables as investment vehicles will inarguably persist through next year, Pullman says.

Of course, as with many hot sectors, mood changes can occur at lightning speed. Corn-based ethanol, which was popular among investors just 12 months ago, is already out of fashion, as production capacity is surpassing government mandates and profit margins for the fuel have all but disappeared.

Some analysts believes companies like VeraSun(VSE Quote) and Aventine Renewable Energy(AVR Quote) should probably be avoided next year until prices for corn fall to a more reasonable level.

Pullman predicts that investors might adopt a more realistic mindset in 2008 and begin to place their investment dollars where they can expect quicker and more reliable results. One sector he believes offers excellent opportunities for growth is solar power.