May 06, 2011

The Long Overdue Energy Boom: Forget $5 Gas, Here is a Much Bigger Energy Opportunity

By Andrew Mickey, Q1 Publishing

Reports of $5-plus gas popping up across the country are a major distraction.

Most consumers are reminded a couple times a week how high gas prices are. The media highlights them every day. They always get a lot of attention.

High prices at the pump, however, are normally more of a distraction than anything else. The most recent run-up is no different.

Right now they’re masking a much bigger energy crunch. And they’re distracting many investors from one of the last remaining undervalued sectors which still offers high current income, low-risk deep values, and that likely will be great place to hide safely from this correction turns out to be the big one we’ve been expecting.

Not Just for Widows and Orphans Anymore

One of the safest sectors to start buying now is utilities.

I know, I know, utilities are boring. They’ve barely moved in the current rally. They’re sitting just off historical lows. Analysts have written off the sector completely. The entire sector is widely out of favor.

Frankly, that’s exactly what is creating an opportunity in one of the few remaining values left in the market.

Now, due to a number of factors that have come together in the last few weeks, utilities won’t be this cheap for much longer.

The catalyst for utilities is coming straight from the top.

The current administration has repeatedly shown it doesn’t plan to be very friendly to any energy industry sector. The last few weeks have proven their intentions beyond a doubt.

In the last few weeks the administration has floated the idea of increases in gas taxes (as part of some nonsensical plan to reduce gas prices).

They have upped the rhetorical attacks on “Big Oil.” They’ve made a big deal out of $4 billion in annual tax breaks to oil companies. The tax breaks, it turns out, go to smaller oil and gas companies that do the majority of exploration and development. So reducing the break will result in less oil and gas exploration and production.

There’s even an effort underway to get the dunes sagebrush lizard onto the endangered species list. The reptile’s addition to the list would essentially cause a shut down much of the oil and natural gas production and exploration in West Texas and New Mexico shut down.

These widely-publicized efforts are just small-time moves in the big energy landscape. And they are taking headlines away from much bigger (and costlier!) regulatory interventions that are going to be a boon to the utilities industry.

The Cold War on Coal

Over the past few weeks the administration has upped its focus on the coal industry by putting the brakes on a number of coal projects.

Most predominantly the EPA revoked the permits for Arch Coal’s (NYSE:ACI) Spruce Mine in West Virginia.

All activity at the mine, which already had $250 million invested into it, was halted because the EPA demanded it needs “enhanced” review due to potential water risks.

This move was just one of 79 coal mining permits the EPA has selected for “enhanced” review. The permits cover proposed coal mines in West Virginia, Ohio, Kentucky, and Tennessee.

The War on Coal, which was largely relegated to a cold war due to the legislative death of a cap-and-trade scheme, has gone hot.

Meanwhile, global coal demand continues to grow. China’s continued appetite for coal isn’t slowing down because of enhanced review. And the U.S. still and will continue to use coal to meet half of its electricity demand.

All of these factors are creating a situation where coal prices could explode.

The risk is not immediate. But when current coal mines are winding down and production begins to decline, coal supplies from the 79 new mines that were delayed by enhanced review won’t be up and running to fill the gap.

This is creating a big opportunity for utilities. Because when coal prices rise, electricity prices follow.

Utility Boom is Overdue

Many electric utilities are in a position to actually benefit from the eventual rise in coal prices.

Those that produce electricity from any other source will be in position to benefit. Nuclear will be the biggest beneficiary. Utilities with large exposure to hydroelectric power generation will benefit as well. Even utilities burning oil and natural gas, although certainly more costly sources, will be in position to benefit as well.

More importantly, electricity prices are due for a significant increase.

According to Amercaspower.org has found the average household’s gasoline costs have climbed from $1,680 in 2001 to an estimated $3,601 this year.

Meanwhile, electricity prices have lagged significantly. The study found the average household’s electricity bill stood at $938 in 2001 and only rose to an anticipated $1,368 this year.

Basically, a rise in electricity prices is long overdue. The regulatory delays of new coal mines could be just the catalyst to do it. And right now utility stocks are in position to make a big run as a result.

Rock Bottom Value

Utilities are one of the few low downside/big upside values left in this market.

The sector is one of the highest yielding sectors in the market. It yields almost two and a half times more than the entire S&P 500.

Standard & Poor’s rates the entire utility sector as “underperform.”

Finally, as a percentage of the entire S&P 500 index, the utilities sector is a mere 3.29%.

This shows utilities are scraping the bottom. The sector has made up as much as 6% to 7% of the entire index during past highs. Also, the sector’s weighting has only reached this low four years out of the past 20. And three of those four years were between 1998 and 2001 when the tech bubble made every non-tech sector a very small percentage of the entire index.

All of this is why boring utilities aren’t just for “widows and orphans” anymore. They are poised to make a big rebound. The current regulatory environment may just provide the long-awaited catalyst to do it.

And given the current market conditions, there aren’t many safer places to be buying into. With relative values hitting historical lows and yields multiple times higher than stocks and treasuries, utilities are a safe and attractive hiding spot for any correction.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing