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Wilf Gobert

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Energy essentials

Wilf Gobert

CALGARY (GlobeinvestorGOLD)—Thanks to the Internet, retail investors can access a substantial amount of the same information used by investment professionals. That is especially so with the energy sector, and the real challenge becomes how to focus your time and energy on the data that really matter and make the smart trade.

How then, do the energy-investing pros begin their day?

If you could look at only one piece of energy information each day, it would have to be crude oil prices. In North America, the benchmark oil price is West Texas Intermediate light quality crude, which is known as WTI and is priced at the Cushing, Oklahoma supply terminal. Investors tend to follow the futures contract—a derivative that guarantees the delivery of a fixed amount of oil at a fixed price at a future date—due to expire in the nearest month and traded on the New York Mercantile Exchange. By comparison, the most quoted price in Europe is Brent crude, a light quality crude oil produced in the North Sea.

Crude oil is a price-elastic, volatile commodity; that is, it responds quickly to news that affects the balance between global supply and demand. Throughout 2002, crude prices have traded above the historical norm of $18 to $20 (all prices in U.S. dollars) per barrel because of supply concerns. During the first half of last year, these concerns sprung from production controls set by the Organization of Petroleum Exporting Countries, or OPEC, the cartel that supplies 40 per cent of the world's consumption.

During the second half of 2002, a so-called "war premium" was added to the price of oil as oil traders speculated on the possibility of U.S.-led war in Iraq disrupting supplies from the Middle East. In December, crude prices soared to two-year highs due to a nation-wide strike in Venezuela that shut-down almost all of its crude exports, which amount to a whopping 3,000,000 barrels per day.

A price for all seasons

On a week-to-week basis, energy investors must watch for the weekly petroleum inventory statistics from the American Petroleum Institute, or API, Screen capture of API's Web sitean industry association. They should also examine data from the U.S. Department of Energy's research arm, the Energy Information Administration, or EIA Petroleum inventories rise and fall on a seasonal basis: climbing before winter begins, declining during the winter, then rebuilding during spring and falling again during the summer. Analysts look for unusual inventory changes, week-over-week or year-over-year. Inventory changes are a leading indicator of swings in the balance between supply and demand and thus an indicator for the direction of oil prices.

Within North America, natural gas markets are also critical to the psychology and direction of energy companies' share prices. Like crude oil, the most quoted natural gas price is the near-month futures contract on the New York Mercantile Exchange, which is more commonly referred to as the NYMEX. The gas itself is delivered at Henry Hub, Louisiana, a major pipeline transmission hub. Natural gas prices also have a seasonal pattern, rising in the fall to a mid-winter peak, falling to a springtime low, and then rallying modestly to a mid-summer high, when air-conditioning demand causes a peak in thermal electricity production from natural gas fuel.

Unlike the worldwide competitors for production and consumption of crude oil, the North American natural gas market is measured by the supply and demand between the United States and Canada. Mexico's market for natural gas is dominated by domestic supply and consumption. Between the U.S. and Canada, the United States consumes almost 90 per cent of total natural gas usage but produces less than 75 per cent of the total.

Annual injection

An indicator of the improving or deteriorating natural gas balance between supply and demand is reported weekly by the EIA through changes in U.S. natural gas storage levels. The American and Canadian natural gas industries maintain underground storage facilities. These facilities inject natural gas into the ground during April through October, when production of natural gas is well in excess of consumption, as the single largest use of natural gas is for residential and commercial heating. In the winter months of November through March, natural gas is withdrawn to meet consumption in excess of production. As with crude inventories, analysts watch for unusual patterns of week-over-week and/or year-over-year inventory changes as a measure of supply and demand.

And don't look to the world's stock market benchmarks for clues to investor sentiment; the energy pros don't look at the Dow Jones industrial average or the Toronto Stock Exchange's S&P/TSX Composite index.

The leading energy index in North America is the Philadelphia Stock Exchanges' Oilfield Service Index, or OSX. This is an index of the largest companies involved in manufacturing, supply and service products for the oil industry, including drilling rigs, seismic services and production equipment. For companies involved in exploration and production as well as refining and marketing of petroleum products, watch the American Stock Exchange's Oil Index, called the XOI, which is composed of many of the world's largest integrated oil companies (production of crude and refining/marketing of products). In Canada, the bell weather energy index is the S&P/TSX Energy Index.

Once you have the fundamentals—crude and natural gas prices—as well as the psychology—the rise and fall of energy shares—on your radar, you can focus your work on the bottom-up approach of finding the most promising stocks.

And the smart trade is only a click or two away.

Wilf Gobert is a managing Director for Peters & Co., a Calgary-based full-service investment dealer.

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