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.
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.
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.
For one, there is a greater emphasis by energy producers to invest in the technology needed to develop and transport liquefied natural gas (LNG). It's a theme expected to be relevant for some time as emerging-market demand is rising. Post-quake, Japan has made LNG a greater focus of its current and future plans for power generation.
New approach. What's more, new techniques for extracting natural gas and crude oil from the earth have helped ease concerns about the inability of U.S.-based energy producers to grow domestic supply and offset the country's heavy dependence on foreign sources for these commodities. These unconventional new drilling techniques have lowered the overall cost structure for companies engaged in the exploration of traditional energy sources such as crude oil and natural gas. More-productive drilling techniques have led to an overall increase in mid-continent U.S. oil production, which has led to lower pricing for refiners, Dowd explains.
Also on the horizon is deepwater exploration. The combination of more-sophisticated drilling techniques, deepwater rigs, and seismic wave and imaging technology have provided energy producers with greater opportunity to explore for energy commodities in previously inaccessible deepwater regions. Many energy producers view deepwater drilling as a relatively untapped frontier that could provide a source of production growth over the next few years. There are a variety of companies that could benefit from this trend, including deepwater rig manufacturers, energy and construction companies, and energy transportation companies.
Global deals and partnerships are also feeding growth. China, for one, is pursuing opportunities in gas. China National Offshore Oil Corp., known as CNOOC, was founded with a mandate to form joint ventures with foreign companies. Last year, the company took a 33 percent stake in Chesapeake Energy Corp. for a shale play in Texas. It made a separate investment for exposure to Canada's oil sands.
The longer-term view backs corporate investment expansion. The International Energy Agency said in its yearly outlook in November that oil demand will rise 14 percent between 2010 and 2035, from 87 million barrels per day in 2010 to 99 million in 2035. What's more, the net increase in oil demand will come entirely from the transportation sector in emerging economies.
To tap into the energy sector, investors can opt for individual stocks or may choose mutual funds or exchange-traded funds (ETFs). Here's a brief list of the top-ranked energy-focused mutual funds by U.S. News:
Vanguard Energy Fund (VGENX): Lost 1.7 percent in 2011; Up 3.8 percent over the past five years; 0.34 percent expense ratio
Invesco Energy Fund (IENAX): Lost 8.3 percent in 2011; Up 4.6 percent over the past five years; 1.1 percent expense ratio
Fidelity Select Energy Portfolio (FSENX): Lost 4.9 percent in 2011; Up 2.2 percent over the past five years; 0.85 percent expense ratio
Icon Energy Fund (ICENX): Lost 5.6 percent in 2011; Up 4.7 percent over the past five years; 1.24 percent expense ratio
Fidelity Advisor Energy Fund (FANAX): Lost 5 percent in 2011; Up 1.9 percent over the past five years; 1.16 percent expense ratio