Why 2011 Could be the Year of the Oil Comeback

Like every investor, I try to read voraciously to get an edge. I’m always on the lookout for investment angles that haven’t gotten much press but could eventually turn into a market-moving event. So my ears perked up last week when I saw that hedge fund traders have recently been aggressively buying energy futures, betting that we’ll soon see oil move up to $100 a barrel. In subsequent days, it’s become easier to see the signs of $100 oil popping up on people’s radars.

For example, on Monday, Saudi oil minister Ali Naimi suggested that oil prices could move up to $90 without hurting global economic growth, up from a previous perceived ceiling of $80. That’s led some to speculate that OPEC will try to maintain production at current levels even as signs are emerging that oil demand has begun to pick up.

#-ad_banner-#Economic growth in emerging markets like Brazil and China remains robust, which led to a 1.4 million barrel jump in the third quarter, according to the International Energy Agency (IEA) and a 980,000 barrel uptick in Western Europe and the United States. Any further uptick in global demand could push oil demand back up to — or above — supply levels.

Analysts at Merrill Lynch see $100 oil by early 2011 for a more prosaic reason: They believe that the U.S. Federal Reserve’s plan for quantitative easing (QE2) will weaken the dollar and raise the price of commodities, particularly gold, silver and oil. [Read: “How The Fed Will Affect Your Portfolio This Week”] The recent move in the dollar is a possible harbinger of things to come, according to Merrill: “We believe that oil is only starting to reflect a weak U.S. dollar against G10, leaving room for oil price rises as emerging market currencies strengthen against the U.S. dollar.”

Make no mistake, $100 oil is not nearly as lethal to the economy as $140 oil was a few years ago, but it still creates serious headwinds and tailwinds in a range of industries. Here a just a few impacts:

  • Airliners see a sharp drop in profits next year as rising jet fuel costs cannot be offset by commensurately higher fares. Carriers have already pushed through steady price increases in the past 18 months, but are pushing the limits of demand elasticity. Notably, while many carriers were nicely hedged against rising fuel prices a few years ago, they have largely bypassed hedging activities in this cycle. If they are to act, they should do so soon.
  • Sales of high-margin SUVs and pickup trucks would likely stall out once again after recent signs of a demand uptick that underpins rising profit forecasts for Ford Motor (NYSE: F) and other auto makers in 2011. [Go here to read my colleague James Brumley’s take on which auto stocks are the best investments.]
  • Consumers would likely feel a pinch at the gas pumps and also at the grocery store, where rising transportation costs would lead to a rebound in food price inflation.
  • Road-based freight transporters such as Con-Way (NYSE: CNW), Arkansas Best (Nasdaq: ABFS) and YRC Worldwide (Nasdaq: YRCWD) have only recently achieved major cost cuts that help to narrow the cost gap between themselves and the rail-based freight carriers. All of a sudden, $100 oil swings the pendulum clearly back in favor of rail haulers like CSX (NYSE: CSX), Union Pacific (NYSE: UNP) and Norfolk Southern (NYSE: NSC). [See StreetAuthority contributor Tim Begany’s three favorite rail stocks set to outperform]
  • The United States is also a potential loser. Despite heated rhetoric from both parties, we still have yet to meaningfully wean ourselves off of imported oil. And $100 oil simply expands our trade deficit.

A green rebound?
Of course, higher oil prices are just what the clean energy industry could wish for. Solar and wind providers have been highly dependent on erratic government policies to support demand and have thus far come away with nothing in terms of a carbon tax that makes their technology comparatively more cost-effective. Yet some projects that were not feasible at $75 oil without subsidies suddenly become more feasible in the face of $100 oil. The PowerShares WilderHill Clean Energy ETF (NYSE: PBW), which surged above $25 briefly in early 2008, now trades below $10, reflecting the recent period of relatively cheap fossil fuels.

If oil moves back into triple-digit territory in 2011, the timing would prove perfect for Brazil, which is in the process of developing massive new oil fields through its quasi-national Petrobras (NYSE: PBR) oil company. Shares of Petrobras came under pressure this summer after it needed to sell massive new blocks of stock to fund development. As a result, shares are -35% off of their 52-week high.

Lastly, a wide range of natural gas companies stand to benefit from surging oil. For starters, it would increase demand as any power plants that can switch between oil and gas make the move to gas. Second, it increases the likelihood that auto makers roll out more natural gas-fueled cars. Honda (NYSE: HMC) is an early leader in this area, Daimler Benz is reportedly set to follow suit, and other auto makers may do so as well. If enough do so, then natural gas prices will finally start to rebound as demand builds.

Lastly, Clean Energy Fuels (Nasdaq: CLNE), which operates natural gas fueling stations, and Westport Innovations (Nasdaq: WPRT), which retrofits big truck engines to run on natural gas, would also be clear beneficiaries.

Action to Take –> Energy has been off of investors’ radars in 2010, but that may not be the case in 2011. It pays to keep an eye on developments in the energy markets: The U.S. economy can tolerate $100 oil — $120 oil is another story. If oil prices start creeping up, you should think about rotating out of stocks in the losing areas I mentioned above and into some of the ideas I mentioned earlier.