December 31,2001; Energy Futures Project Calm Fundamental Outlook

The futures market projects a stable oil price and a rising natural gas price (see Chart).  A sense of calm has returned to the markets after the turmoil of a year ago.

The futures curve for oil has been swishing like an animal's tale the past two years.  The base as represented by 2006, has been stable for more than a year.  The tip as represented by February 2002 has wagged to $29 on the high side and $19 on the low side (see Chart).

The animal tail analogy cannot be as readily demonstrated in natural gas, as public quotes for out years have been available only since Enron's private quotes dried up.  While we like the positive slope of the newly available public curve, we also note that quotes for the early years have been in a downward trend (see Chart).  There may be further weakness in the early months, but we expect the further out months to be stable.

We present futures prices as a widely representative reference point.  We make our cash flow estimates consistent with futures prices.  Just because we use futures doesn't mean we agree with them.  We are more bullish long term than the futures market and hopeful near term that reality does not turn out to be worse than the futures market implies.

Seasonal Strength in Refining Good For Marathon Among Others

Investors who like to concentrate their buying in the off-season might look upon the refining business with greater interest again.  Coming off great profits in the first half of last year, the refiners have had tough times in December.  Futures imply margin strength, though not a lot, in April and beyond (see Chart).  The margin is derived from New York Mercantile Exchange quotes by subtracting prices for one barrel of heating oil and two barrels of gasoline from three barrels of light sweet crude oil.

Investors who have been holding back acting on our Strong Buy recommendation of Marathon Oil might be more comfortable acting ahead of refining margin improvement.  MRO is about a third natural gas, a third oil production and about a third refiner/marketer in concentration of value.  On another score, the timing to buy Marathon may be the best in two decades because on January 1 the company will be a standalone integrated oil company as it was until 1981.

Seasonal Strength in Electricity Good for Natural Gas Producers

Electricity futures point to price strength in the hot summer months of July and August.  A positive spread between the price of electricity and the price of natural gas implies profitable operations for companies that generate electricity from natural gas (see Chart).  It implies even more profitability in an unregulated environment for companies that generate electricity from low cost coal and nuclear plants such as those owned by recommended American Electric Power (AEP) and Exelon (EXC).

There is remarkable operating leverage in electricity for natural gas producers as evident by price swings on the chart above compared to the chart for natural gas.  In the off-season there is enough cheap coal and nuclear capacity that we don't need much gas to be converted to electricity.  In the peak season we need natural gas.  Moreover, generators can afford to pay a lot.  As electricity demand grows, cheap capacity will remain fixed while natural gas fueled generators meet incremental demand.  The peaks we see on the price curve will spread increasingly across the year.