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By Ryan Puplava CMT

Energy is an emerging interest for the market as portfolio managers search for value in energy stocks. One of the biggest topics discussed at the beginning of the year was valuations. You need to look no further than energy, old tech, materials, and utilities to find value this quarter. In addition to value-seeking portfolio managers, we saw the value of cheap natural gas as a political tool with the advent of Russia's expansion into Crimea. It was a short-lived event that will probably have long-term effects that I will discuss shortly.

The chart below shows the price of an S&P 500 growth ETF (NYSEARCA:IVW) divided by the price of an S&P 500 value ETF (NYSEARCA:IVE). It shows an emerging trend shift into value stocks over growth stocks. There's no telling how long the trend will last, but this is a significant event. Last year's rotation into growth began in July and only just recently ended in an abrupt manner.

ivw:ive 9 apr 2014

The recent resurgence in performance of materials and energy could also be related to the sector rotation model. If industrial, technology, and consumer discretionary stocks were the best performers last year, basic materials and energy are the next logical sectors to see a rotation as the economy enters into the full recovery stage and investors realize we are in a bull market. Average real GDP growth last year was 2.6%. That's not the kind of rates we'd expect to see if the economy was overheating and with unemployment still at 6.7%, we have slack left in the system still.

sector rotation update

Select industries within energy were working last year (shale plays and LNG). At this point, I believe they're all working, which is certainly a boon for energy investors and is also the reason why my energy portfolio is diversified across the different industry groups within the sector. The truth is: I don't have enough cash to buy all the stocks I like and that's a good problem to have for energy investors.

Developments

The EU recently held discussions this Tuesday (4/8/14) to discuss the threat of disruption to natural gas supplies from Russia. Russia's invasion of Crimea and war games along the rest of the Ukrainian border have resurfaced tensions between Europe and Russia over the eastern bloc. The only threats that have been waved around have been economic sanctions, and natural gas supply is the ace up Russia's sleeve should Europe propose any serious economic sanctions.

http://cdn.static-economist.com/sites/default/files/imagecache/original-size/20140405_EBM952.png
Source: The Economist

Europe doesn't really depend too much on Russia during their summer months for natural gas, but that's when they use the supplies to stock up for the winter. Europe just had a mild winter so storage levels are high relatively speaking, which will give Europe the buffer they need to lower their dependency on Russian gas in the near-term, while increasing imports of U.S. gas over the long-term.

http://cdn.static-economist.com/sites/default/files/imagecache/original-size/20140405_EBM145.png
Source: The Economist

On that note, politicians in the U.S. are actually doing "good work" in the energy sector. Department of Energy (DOE) has been approving applications for LNG exportation at an alarming rate recently. Last year, they approved six applications and two thus far in 2014 including February approval of Sempra Energy's (NYSE:SRE) Cameron (L.A.) terminal and Jordon Cove Energy project LP's Oregon coast project in March. On discussing the recent approval, U.S. Senator, Lisa Murkowski (R-Alaska) had this to say according to the oil and gas journal:

This announcement is exactly what Coos Bay, North Bend, and America need: new jobs and new investment, while factoring in a changed geopolitical landscape through a case-by-case process…(which) given the situation in Ukraine, this license sends a positive signal to our allies and to energy markets that the United States is ready to join the growing global gas trade.

(story)

Natural gas has become a shining beacon of American macroeconomic capability to the rest of the world.

  • 11 terminals export LNG
    • 6 in the Gulf
    • 5 along the east coast
  • 25 non-FTA applications under review
    • 6 last year
    • 2 thus far in 2014

Winter Stocks

Gas is the major story in 2014, not oil; however, new pipeline capacity is helping to lower inventories at the Cushing, Oklahoma storage hub to 27 million barrels by the end of March, the lowest since November 2009. The pipeline is sending more capacity to the Gulf refineries. The EIA expects gas prices to remain fairly stable this summer with a $3.57/gallon average price between April and September based on the futures and options contracts for key petroleum components.

The harsh winter of 2014 has created a decent shock to natural gas inventories. According to the EIA's short-term energy outlook report:

[N]atural gas working inventories on March 28, 2014 were 0.82 trillion cubic feet (Tcf), 0.88 Tcf (52%) below the level at the same time a year ago and 0.99 Tcf (55%) below the five-year average (2009-2013).

That's why natural gas prices remain elevated even though traders have been expecting the winter weather to thaw (up 35% YTD, April 9).

(click to enlarge)

Summary

Winter has come and gone, but energy is still needed. Our summer months will be used to rebuild inventories, depending on how warm it gets. There is decent meteorological evidence that odds are increasing we'll have El Niño conditions in 2014 which increases chance of droughts, typhoons, and heat waves. Confidence is growing because the Niño 3.4 region of the tropical Pacific Ocean south of Hawaii shows sub-surface warm water. As the trade winds reverse direction pointing eastward, that sub-surface water blob will rise and move eastward boosting temperatures and changing weather patterns.

FT-140407-ElNino
Source: Australian Government Bureau of Meteorology

Not only do we have the harsh winter conditions, we are likely to have a very warm summer. Utility bills are likely to stay high! And then there's the development of a gas-cold-war with Russia that seems to be developing. It's going to be an interesting year in energy.

Source: Year Of The Gas