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Will It Be A Happy New Year For Energy Investors?

It has, to say the least, been an interesting year for energy investors. 2014 started with everything looking rosy. The global recovery was in full swing, the price of oil and gas was fairly stable and climbing, and the “energy revolution” in the U.S. was in full swing. Unconventional drilling (primarily hydraulic fracturing, or fracking) had opened up huge reserves of oil and gas in the U.S. and elsewhere that were just beginning to come on line. Even alternatives were looking good at the start of the year, with solar companies in particular finally beginning to turn potential into profit. By the end of the year, though, everything had changed.

Inside Opportunities Chart

As I pointed out in the very first piece I wrote here, oil prices could not keep going up. The increasing supply was outpacing demand increases, in oil particularly, and economics 101 suggested that a correction would have to come. What neither I nor seemingly anybody else anticipated was how severe that would be. A strong Dollar and evidence of slowing growth in Europe and emerging markets, particularly in China, combined with that supply and demand imbalance to produce what can only be called a collapse in the second half of the year.

Anything even vaguely related to energy went with the oil price. Stocks tumbled, with the small companies with exposure to expensive shale and deepwater plays hit hardest. The question for investors, of course, is how low can we go? There is no logical, chart based support for WTI crude until the 2009 low of around $40 is reached, which suggests that, despite some support in the $50-55 level, energy investors would be best advised to wait and see before looking for value. It should be borne in mind, however, that those levels were reached at a time when the entire global economy was collapsing.

Increased supply notwithstanding, we are hardly at that point. The rate of increase in demand may be slowing somewhat, but it is still growing. Similarly, the rate of supply, while still growing will naturally start to increase slower as less plays become profitable. Continued instability in the Middle East and the unpredictability of Russia can only lend support to the price. A gradual increase in U.S. interest rates is now fully priced into the Dollar, so when it comes some “buy the rumor, sell the fact” action could see some retracement of the currency. All of these factors combined indicate that, starting at these levels, 2015 will turn out to be a decent year for energy investors.

Some care will be needed, though. At least initially, there could be more trouble to come for many of those small, highly leveraged companies committed to unconventional production of both oil and gas. Initially, companies that have been dragged down with the general drop, such as the large multinationals, mid and downstream oil companies and the like should be favored. Solar and other alternatives should be avoided early in the year. The lower oil price reduces the urgency of transition to renewable energy sources. No matter how compelling the economic and national security issues may be, trusting politicians to take a long term view and forego a short term advantage is a losing proposition.

There will probably be some consolidation in the industry early in the year as the big, cash rich companies look to take advantage of the struggles of the smaller firms, so identifying likely takeover targets should be a priority early next year. Other than those opportunities, though, it will be a year to average into energy with a long term view. Supply is still at a level that produces a surplus and correcting that situation will take time.

Overall, then, 2015 looks likely to be a year of gradual recovery in the energy sector. It is likely to be a year where taking a chance on individual picks will provide better returns than broad based sector ETF investment and some agility will be needed as opportunities come and go. There will be ups and downs (or, more accurately, downs and ups) but when looking back a year from now, I suspect that we will all be saying it was a pretty happy New Year.

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