Energy Recovery Won't Be Easy in '09

Forecasting groups and economists are predicting that the downturn will last though a good deal of 2009, if not longer, a trend does not bode well for companies that rely on strong energy prices to remain profitable.
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Though seasonal patterns and supply cuts might prop up petroleum prices at certain points next year, analysts and traders are nearly certain that the record oil levels reached during the summer of 2008 won't be seen again any time soon.

Though oil surged to nearly $150 a barrel in July, it has come down to less than one-third of its summer height as demand from consumers and businesses around the world slumped. Other products, like natural gas and heating oil, followed suit.

Forecasting groups and economists are predicting that the downturn will last though a good deal of 2009, if not longer, a trend does not bode well for companies that rely on strong prices to remain profitable.

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The International Energy Agency predicts that demand will drop in 2008 for the first time in 25 years, and will move up slightly next year, but only if the global economy gradually recovers. However, with energy-conscious consumers turning off the lights and driving less, and businesses laying off employees and curtailing production, it is far from clear when things will begin to improve.

Brian Milne, the refined-fuels editor at DTN, expects the "sluggish consumption rate" to certainly last through the first quarter, which is seasonally the weakest demand period for gasoline. Milne's price estimates have a wide range.

He believes crude oil will trade in the $40-a-barrel area at the start of the year, but has a potential upside as high as $75 a barrel. He says gasoline could drop below $1 a gallon, but move up to $1.30 as spring approaches.

Refiners have been hit hardest by paltry demand this year, with margins hurt severely as gasoline prices failed to keep up with the pace of crude.


(VLO) - Get Report

, the largest U.S. refiner, said last week that it would cut production sharply to buoy margins, following similar moves by


(SUN) - Get Report



(MRO) - Get Report


Unfortunately for the sector, an uptick in demand may only be supported by cheap prices, as the world's biggest energy consumer, the U.S., works through its recession and other countries take pause.

At the other end of the spectrum, firms that explore for and produce petroleum are suffering from a lack of financing in the risk-averse credit markets. Integrated firms with cash on hand have also stalled or canceled projects due to uncertainty about when demand will strengthen. Escalating prices seemed to guarantee that investments would pay off, but now it's not so clear if or when that will happen.

Callon Petroleum

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Royal Dutch Shell





and plenty of other small private firms, as well as national oil companies, have suspended projects to search for more supply or upgrade facilities.

Others, like

Devon Energy

(DVN) - Get Report

, have slashed forecasts for capital expenditures.

But while the Amex Oil Index has slumped about 40% this year, it could present an opportunity for investors hoping to pick up shares of major conglomerates, such as

Exxon Mobil

(XOM) - Get Report

, that have come down in price. Greg Womack, president of Womack Investment Advisers, says stock pickers should look for firms with rich dividends as hidden gems in the battered energy space, as well.



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, Exxon and midstream

limited partnerships that are paying good cash flow of 6% to 9%, with good business models, that have managed debt well in the downturn," says Womack. "It makes good sense to consider those for a steady income stream."

Another area that has potential is renewable energy, though the outlook is still shaky for the near term. Broadly speaking, the sector will likely receive a windfall from the Obama administration's agenda, which is full of promises to develop green technology and push it into the mainstream.

But such initiatives will likely take time to be implemented, and private investors aren'tt flocking to fund research and development for emerging technology. The government's massive bailout of the financial industry could make it difficult to finance such ventures, as well.

It's also unclear which companies within the sector stand to benefit the most. Solar companies need state and federal tax subsidies to entice homeowners to install their panels, yet cash-strapped states may be less willing to support them. The technology is also less useful in states or areas where sunshine is limited.

Similarly, wind power can only work where the wind blows, and the industry faces some opposition from coastal residents who don't want massive wind farms blocking their scenic views.

And though ethanol was a boon for corn farmers in the Midwest, it is also plagued with difficulties, both economic and environmental.

Nonetheless, Obama's creation of an energy team with a focus on independence and renewables has provided optimism for the sector. He has named Carol Browner, the former head of the Environmental Protection Agency, as a renewable-energy czar, and installed several other officials who have expressed support for conservation and alternative energy.

"The folks that they've chosen are complementary," says Julie Blunden, a vice president of solar company



. "Most of them know each other and they have a breadth of experience across the country, including several markets that are important to renewable energy going forward."

Until it's clearer which companies will reap the benefits from the renewable push, another area for investors to explore is natural gas, which burns cleaner than crude-oil products or coal. Lisa M. Zembrodt, a commodity analyst with Summit Energy, says that while natural-gas prices have plunged along with other energy prices, the slump isn't sustained by fundamentals.

If the sector regains favor, producers such as

Chesapeake Energy

(CHK) - Get Report

, and integrated firms like


(APC) - Get Report



(APA) - Get Report

, could stand to benefit.


Natural gas is often considered the bridge between when we can get some really, really clean-energy consumption in place," says Zembrodt. "It can serve that purpose until we can really get a true infrastructure for significant amounts of solar power or wind."