Demand and Disasters Complicate Global Energy Picture
Andrew Leckey

The global energy picture has become more complicated in 2011, but investors are making some sense of it.

The nuclear outage in Japan and turbulence in oil-producing nations is prompting increased demand for alternative electricity sources such as natural gas and coal, though both carry some environmental concerns. While solar energy has also become more attractive, it remains dependent on government support.

"Our energy challenge is constantly being highlighted by issues around the world, and it has been made clear that we have no magic bullet to call upon," observed Fred Sturm, portfolio manager of Ivy Global Natural Resources Fund (IGNAX), whose diverse energy portfolio has a 12-month return of 26 percent. "The answer for the years ahead will be that we need numerous energy sources, including natural gas."

Strong economic demand in India and China means nuclear power expansion is likely to continue, he believes. Factors such as the ongoing growth of consumer and business electronics -- even the potential of electric cars -- will add to the world's demand for electricity. That demand is also why natural gas will play a significant role in the power generation mix, he said.

Cabot Oil and Gas (COG), an independent producer that derives 95 percent of its production and reserves from natural gas, is a stock that Sturm recommends in that industry. Its operations are in the U.S. Gulf Coast, Appalachia, the mid-continent and the Rockies. Cabot's large base of undeveloped properties in the U.S. could provide several years of lower-risk drilling though it is, of course, susceptible to declines in natural gas prices.

Noteworthy is the ongoing controversy over the natural gas industry's process called "fracturing," the injecting of enormous volumes of water mixed with sand and chemicals deep underground to fracture rock formations and release natural gas. While the Obama administration favors increased development of natural gas, the administration, regulators and activists have expressed concern that water supply and air quality not be endangered in the process.

Diversity of energy options will be key.

"Events such as those in Libya tend to create overreaction, and investors should not get led down a certain path based simply on these disruptions," warned Michael Byrum, portfolio manager of Rydex Energy Fund (RYEIX), which has a 12-month return of 31 percent. "Long-term investors should not get caught up in short-term disruptions, but rather use disruptions to buy into certain segments a bit more cheaply."

Energy and the economic cycle are always tied together, said Byrum, whose fund takes a quantitative approach, with the biggest energy companies as its largest holdings. With increases in manufacturing and economic activity, there is likely to be demand for these kinds of companies, he said.

Coal has long been controversial on numerous counts, among them pollution caused by emissions of contaminants such as sulfur dioxide, nitrogen oxides and mercury, as well as emissions of greenhouse gases believed to add to global warming.

Nonetheless, it always seems to hang around. Demand has been especially strong in Asia this year due to reduced supply from torrential flooding in Australia that restricted its coal exports.

"Japan's difficult events benefit the coal industry and, with the affected nuclear facility gone, more coal imports will be needed," predicted Michael Tian, analyst for Morningstar Inc. in Chicago. "If China and India are to have electricity, they will be very dependent on sources that include coal power."

Demand is tied directly to GDP growth reflecting consumer, commercial and industrial growth, he noted. The world's coal market is closely linked, so higher coal prices in one part of the world always eventually translates into higher prices elsewhere.

Here are some coal stocks Tian considers worth monitoring:

-- Peabody Energy (BTU), world's largest private-sector coal company, fuels more than 10 percent of U.S. electricity generation and 2 percent of electricity worldwide. It has mining operations in the Southwest, Midwest and Wyoming's Powder River Basin. It has a unique presence in Australia and also vast undeveloped coal reserves in the U.S.

-- Alpha Natural Resources Inc. (ANR), one of the largest coal miners in North America, operates in central and northern Appalachia as well as the Powder River Basin. It is also the largest U.S. producer of metallurgical coal, also known as met coal or coking coal, which is used in the production of high-quality steel. Since China does not produce metallurgical coal, some estimates place Chinese demand for it at more than 100 million tons annually. Alpha Natural Resources acquired Foundation Coal in 2009 and is buying coal producer Massey Energy this year to further expand its footprint.

-- International Coal Group Inc. (ICO), which produces coal in northern and central Appalachia and the Illinois Basin, was formed from the assets of three bankrupt coal companies. Its capital investments are paying off; it improved its balance sheet with 2009 and 2010 stock issues; and its workforce is completely non-union.

"It is fine if an investor feels confident about individual company stocks, but another alternative is to buy an exchange-traded fund," concluded Tian, noting that the Market Vectors Coal ETF (KOL) that tracks a global index of coal companies provides another alternative.

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