The Outlook for Investing in Energy in 2012

Global demand is important, but so is the production side of the equation.

By SHARE

With the European debt crisis unresolved, the U.S. economy crawling along, and signs pointing to slower growth in China, the bullish outlook for energy prices is not bulletproof.

Still, optimism for commodities and related sectors cannot be denied. Global energy demand will climb 1.4 percent, with China accounting for more than a tenth of the energy used, in 2012, according to the International Energy Agency. Expectations for consumption in India and Brazil are also supportive of the global picture—even more so over the long term. Japan's energy demand is on the rebound after the earthquake and tsunami of early 2011.

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Importantly, demand is only half of the story for investors, analysts argue. Just as vital is the progress that North American companies are poised to make with exploration and production.

Barclay's Capital research shows that major exploration and production (E&P) companies have hiked their planned expenditures for 2012 to a cumulative $600 billion.

The price outlook for commodities may be encouraging such growth. Analysts predict crude oil prices will rise for a fourth straight year to a new record average in 2012. Based on the median of 27 analyst estimates compiled by Bloomberg, West Texas Intermediate (WTI) oil traded on the New York Mercantile Exchange will reach an average of $100 a barrel next year, exceeding the record average of $99.75 of 2008. There are slightly more conservative estimates to consider; the Energy Information Administration expects WTI to average nearly $94 a barrel.

Even in the worst-case scenario, the downside to oil prices is unlikely to be anything as severe as during the 2008-2009 cycle. As a result, Barclays analysts are maintaining their price forecast of $115 per barrel for London-traded Brent crude in 2012. They expect $90 per barrel to hold as a sustainable floor even under worse-than-expected macroeconomic conditions. For its part, the Organization for Petroleum Exporting Countries (OPEC) in mid-December set a new target of 30 million barrels daily, roughly in line with current production.

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Fitch Rating's stable outlook for the North American oil and gas industry is supported by balanced capital structures, strong underlying assets, and robust liquidity support. Extremely loose Federal Reserve monetary policy, which has been pledged to remain in place into 2013, should help bolster solid demand.

Spending money to make money. North American natural-gas prices, meanwhile, could hit multi-year lows next year as increases in supplies of shale-based natural gas continue to outpace domestic demand growth for that fuel, according to Fitch analysts.

But that's not yet discouraging exploration in natural gas. Much of the E&P budget will go toward finding and developing natural gas reserves. By some accounts, the emergence of natural gas is the best alternative to depleting oil reserves, and that has pushed oil majors and minors—Schlumberger, Baker Hughes, Halliburton, and Weatherford International among them—to pursue newly found unconventional reserves.

During the past couple of years, the energy sector has become increasingly more complex. Geopolitical tensions in the Middle East and North Africa have raised the risk of oil supply disruptions. The major spill in the Gulf of Mexico in the spring of 2010 raised the probability of increased industry regulation for U.S. oil producers—a source of uncertainty with regard to future earnings, said John Dowd, a Fidelity portfolio manager, in a recent presentation.

Those issues are big ones, but shouldn't dissuade investors from a closer look at "a few compelling dynamics underway in the energy sector that have the potential to significantly alter the landscape and provide attractive opportunities for long-term investment," he said.

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