Energy Outlook

Published on Wednesday, 23 May 2012 21:38 Written by Todd Shriber

Plagued by a strengthening U.S. Dollar and lingering doubts the Euro Zone will last under its current makeup, among other factors, oil futures are under siege. On Wednesday, NYMEX-traded crude lost $2.14, or 2.3%, to settle at $89.71 per barrel. That’s the first settlement below $90 for the benchmark U.S. contract since early November. Since the start of May, U.S. oil futures have tumbled 15%.

Conversely, natural gas futures are on fire. In the past month, the U.S. Natural Gas Fund (NYSE: UNG), which tracks NYMEX-traded natural gas, is up 31.3%. After falling to a decade low of $1.90 per million British thermal units last month, natural gas futures have jumped 44%. For years, it was the other way around. Oil futures would rally while natural gas futures would falter.

Now the question is this: Is the recent action between the two major energy commodities a sign of things to come? It’s a tricky question to answer, but the near-term trends for oil, at least in terms of price are not encouraging. Demand in the U.S. and China, the world’s two largest oil consumers, is slack. Albeit modestly, domestic production is increasing in the U.S. Combine that with weak demand and it is no wonder that U.S. oil inventories remain at 22-year highs.

There are upsides to oil’s downside. First, lower oil prices free up more discretionary income within the U.S. economy. Second, even though energy stocks are a vital component of the broader stock market, many of the mid- and large-cap oil companies can still make tidy profits when oil is at $70 or $80 per barrel. In fact, that price range might be more attractive than $110, $120 or $130 a barrel, because prices over $120 usually lead to demand destruction.

Regarding natural gas, it can be said that the commodity is now overbought and there is resistance in the $2.75 per MMBtu area. However, that’s more a near-term headwind. The U.S. Energy Information Administration recently lowered its 2012 natural gas production outlook while boosting the its demand forecast. For several years, it has been excessive production of natural gas that has played a leading role in pushing prices lower.

Since that forecast was released, production has only modestly diminished, just about 1% per day and that’s not enough to make a legitimate dent after years of oversupply. At the very least, it’s a step in the right direction.

Plus, it cannot be forgotten that natural gas some wind at its tail because electric utilities are opting for cleaner-burning gas over coal, another byproduct of depressed natural gas prices. Then there is rising liquefied natural gas demand in Asia. The glut of natural gas here in the U.S has prompted plans for billion-dollar North American liquefied natural gas export plants so excess gas can be imported.

All of that is to say the future of natural gas and maybe its price outlook appear bright. For investors, that’s good news, especially because many of the traditional oil stocks they already own such as Exxon Mobil (NYSE: XOM) have significant gas exposure.