Playing Energy’s Supply-Demand Squeeze

05/31/2007 12:00 am EST

Focus: COMMODITIES

Peter Way

Founder and CIO, Peter Way Associates

Peter Way, editor of Block Traders’ Oil & Gold Monitor, discusses the long-term imbalance between energy supply and demand and its implications for energy prices and stocks.

As an oil stock analyst I learned three very relevant things:

1. Energy consumption is a factor in just about every facet of civilized activity, and as society advances energy demand is certain to grow.

2. Energy sources exist in almost unlimited supply in various forms around the world, but some energy demands may only be served by sources in specific forms. Many energy sources can be converted from one form to another, but always at a cost.

3. The profits of energy source providers depend primarily on what it costs them to deliver that form of energy being demanded in each market, and what those markets are willing and able to pay for it.

Cheap and easy-to-provide resources always get used up first. Liquids that flow in great volume are very cheap to extract, and those that can be easily reached now are largely gone or committed. It’s all uphill in cost and effort from here.

The scope of the world’s energy needs and the pace of civilization’s progress guarantee that no easy, quick sources have escaped consideration. The size of worldwide energy demands and the current yearly increments to demand are beyond the ability to grasp of many observers.

New-reserve finding rates by the oil and gas industry have lagged consumption now for over a decade. Alternative energy sources will have to make up the difference as the cheap [ways] to produce reserves diminish and are increasingly held for usage in applications for which they are best suited. The fact that the alternatives are always more costly to use is what is keeping crude oil prices and refined product prices as high as they are.

Investors in companies holding oil, gas, and coal reserves will continue to benefit for some time as the supply-demand shortage intensifies and is reflected in crude oil prices. The service and transport companies supporting the producing companies will benefit as the value of lost opportunity to produce rises with the increase in crude.

The Big Oils only offer two names that look to be attractively priced, Cnooc (NYSE: CEO) the Chinese producer, and Canadian Natural Resources (NYSE: CNQ), a tar sands play. (Both were near their all-time highs Wednesday—Editor.) Several of the others appear fully priced.

As has been the case most frequently, the better opportunities are still in the exploration and production independents. Outstanding prospects appear to be in Range Resources (NYSE: RRC), Carrizo Oil (NASDAQ: CRZO), and Toreador Resources (NASDAQ: TRGL). (RRC and CRZO were close to their all-time highs Wednesday while TRGL traded just shy of $16, well off its 52-week high—Editor.)

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