Diversification Within The Energy Sector May Be A Prudent Strategy Whose Time Has Come

Continuing oil price support from the weak dollar could easily keep you and your clients thinking that strength in oil market won’t flag anytime soon. But since every market cycles, diversifying within the sector might be a prudent risk management strategy as well as a savvy value investment strategy. 

The energy and health care sectors previously underperformed but they have led the run in the market since the first of the year. Oil prices rose 4.2% in the first quarter of 2012 based on ongoing concerns about Iran, the improvement in consumer sentiment, and continued weakness in the dollar.
 
While crude oil prices are still at significant highs, natural gas prices are at historic lows. Natural gas prices are measured in British thermal units (BTUs) and are currently at a new low of $2.50 per million BTUs. Prices for crude oil and natural gas once were highly correlated but since early 2009, crude oil prices have risen 167% and natural gas prices have only risen 50%.
 
Until demand increases to a point where it begins to use up the current glut in supply, natural gas investment can be viewed in four strategic ways:
 
  1. Margins on crude oil have become much narrower. The wider margins offered by natural gas are motivating some oil-producing companies to convert to natural gas production.
  2. Companies are being created which focus on converting petroleum-based engines to natural gas engines.
  3. Converting oil companies are not only converting their production to natural gas; they are actively involved in creating a nation-wide network of natural gas fueling stations.
  4. Natural gas can be liquefied. This makes it possible for companies to buy it in the US at historically low prices, then export it to countries where prices are higher.
 
It may not be feasible for regular users of gasoline and diesel engines to convert to natural gas engines, but long-haul truck owners can justify the cost of conversion ($50,000) over one year’s time. The long-haul truck market may be a new focus for companies that convert.
 
New companies  are specializing in technologies designed to bring conversion costs down.
They’re also making it easier to convert natural gas to a liquid form that can be shipped abroad. Natural gas prices are expected to stay low for some time so companies equipping themselves to export to Europe and Asia can sell at multiples of four to six times US prices.
 
The mild winter has only added to what has been a developing trend in natural gas prices and supply for several years now. You can keep up with what’s happening in the energy sector on the US Energy Information Administration’s (EIA) website.
 
The EIA’s Petroleum Monthly Supply report comes out Monday April 2nd at noon.  This report is a good way to keep tabs on the oil market. To find EIA data on natural gas, go here.
 
Energy sector investing may not be an appropriate portfolio focus for every client. But if you’re looking for ways to manage risk in a volatile sector, diversifying into a long-term value play within the same sector may be a strategy that makes sense.

 

 

 

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