UNDERSTANDING THE ENERGY MARKETS.

Azaleas Native To Big Thicket.

The Picture Above The picture really doesn't relate to this week's topic. I am including it only because it shows a very unique flower. Azaleas that grow native in the Big Thicket where I live. While they lack the vivid colors of those we plant, their delicate, tropical like appearance increases their appeal.

Inefficiencies In Energy Prices. Everyone is complaining about the cost of driving a car. Gasoline prices are in the high three dollar range in most places. Many complain that the cost is being driven up by speculators rather than by supply/demand imbalances. Some congress persons are talking about legislation/regulation to curtail speculative activity. While there is little doubt that speculators influence the price of energy, calling for limits to our freedom to buy and sell for future delivery is but one more example of a government that is trying to control things they don't understand. Suppose I know I will need to purchase a million gallons of fuel in September, I can either worry or buy a contract for a million gallons for September delivery. If the price stays the same, I can sell my contract or take delivery. If the price drops, I can buy on the spot market and recover my part of my futures investment by selling my contract (at a loss). Of course, there are numerous other options but the point is buying or selling contracts for future delivery involves risk but this activity gives me more tools to manage that risk. If there is considerable uncertainty in the marketplace, like the potential for more political unrest in oil producing nations, the cost of buying futures contracts will increase. If there is a huge discovery of high grade oil in West Texas, the cost of buying futures contracts will decrease. There is little the government can do about that.

Energy Is Energy. We talk about buying natural gas by the cubic foot, coal by the ton, and oil by the barrel. It's hard to compare one energy source to another using this kind of pricing. We usually assume that energy from each substance will be priced efficiently. Not true. Natural gas prices are around two dollars per one million energy units (BTU). Oil is $105 per barrel. Since a barrel of oil contains 5.8 million BTU, a barrel of oil should be around 5.8 times that of a million BTU of natural gas. Traditionally, a barrel of oil has been priced at a bit more than this, ranging from six to nine times the price of gas. In the current market place, with oil at $105 per barrel and natural gas at two dollars per million BTU, the ratio is 52.5. This would point to the conclusion that either oil must come down or natural gas must come up. Knowing this should allow us to spot investment opportunities. There is little doubt that the current ratio of oil prices to gas will return to something closer to the historic average.

What's Going On With Natural Gas. You would have to be in jail without a TV or computer not to have heard about new discoveries of natural gas in shale formations in several areas around the continental United States. Natural gas is being produced at a rate faster than we can use it and we are reaching a point where storage facilities are full. The facilities we have built to import liquefied natural gas from other countries are now being considered for rehabilitation to allow us to liquefy natural gas for export to countries where demand is higher than in the US. Several companies are looking to convert our fleet of trucks to run on natural gas and major car companies are considering switching pickup trucks to run on natural gas. There are numerous political and technical problems to overcome but we can not afford to keep importing petroleum products when we have our own source of energy which is much more affordable than that which we import from other countries. Cheap natural gas also puts a damper on other forms of so-called green energy which is not yet economically feasible.

What Are The Implications of All This. Think about it. For all the talk about battery operated cars, there may not be any net energy savings. Even if they had a battery that had a range equal to a tank of gas, when you plug the car in to recharge the batteries, you are actually, burning the fuel used to generate electricity, right now either natural gas or coal. You will discharge CO2 from these plants just like you do from the tailpipe of your car. The only reason it may be cheaper to operate your car on a battery is that electricity using natural gas or coal that is cheaper than petroleum. My guess is that the price of natural gas will increase as we discover more ways to use it. This will put a lid on oil prices and we are probably not looking at huge increases there either. Of course, all bets are off if there is a major disruption in mid-east oil.

Answers From This Article May Not Be all That Forthcoming. I am not sure that my knowledge of this subject is yet sufficient to be of significant value but I hope I have aroused your curiosity to follow some of the news in this area. Now that I have done some research in this area, I hear more and more news through common sources that give me ideas as to future investment activity.