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By Brendan Coffey

Back before Memorial Day this year, gas prices appeared primed to churn ever higher and provide a hard hit to Americans’ wallets. At the start of May, the national average price of regular self-serve gasoline was $3.94 a gallon, according to AAA. But instead of climbing higher, gas prices eased to $3.60 a gallon in the height of summer–unexpected because normally that’s when we drive the most and a lot of refinery maintenance occurs, nudging up prices. Today the average per-gallon cost of gas is even lower, at $3.40 a gallon.

It’s not cheap, but if you’re like me, you’ve gotten used to it. It’s only when my wife and I pack up the kids and leave Massachusetts to visit family in New York, which has higher gas taxes, that I get a frisson of price shock–gas on Long Island is 27 cents pricier.

This got me thinking–what is the chance that we’ll see fresh gas price shocks, driven by more than crossing over into another state with higher fuel taxes? Analysts at McKinsey wondered the same thing recently, and analyzed the market to see what lies ahead.

Over the past decade, world oil demand has grown about 8.5%, from 77,738 barrels a day to 84,200, according to the Energy Information Agency. The growing economies of China, India and Indonesia have been the primary drivers behind this increase. But while demand has grown, getting more supply out of the ground has been harder.

In fact, capacity has risen only a smidgen over 1% annually. According to McKinsey, there are about three to four million barrels of spare capacity in the world market. Under a “business as usual” scenario, in which the world is much like today and oil doesn’t average over $100 a barrel annually, by 2020 capacity and demand will be equal, at 100 million barrels. That might cause a lot of problems, either quickly or slowly.

The quick problem of nearly matched supply and demand is that any uptick in demand for oil, such as an economic boom, puts pressure on the marginal capacity of the oil industry and sends prices skyrocketing. Look at pre-crash 2008, when prices spiked to $147 a barrel and gasoline ended up at a record $4.11 nationwide that July.

A lack of excess production capacity also means that anything that slices off capacity has far more impact than it should, be it a hurricane in the Gulf of Mexico or saber-rattling in the Persian Gulf.

Then there are the slow problems. Even as gasoline prices have eased off their spring highs, we’re still paying a lot more at the pump, about 22% more than one year ago. The fact that I have adjusted somewhat to the new price of gasoline reminds me of the story of the frog and the hot water.

You’ve undoubtedly heard this before–drop a frog into a pot of hot water and it will jump out. Place the frog in tepid water and slowly heat it up and the frog will sink into a stupor as it eventually boils to death. It’s not true for the frog–which has a very small brain–but it is true of humans; our large brains sometimes fail us.

Under this scenario, slowly but steadily rising oil and has prices continue to commandeer more of Americans’ disposable income, leaving less money to spend on goods and services.

McKinsey (and others) project that energy prices will rise faster than Americans’ income, meaning gasoline could consume 7% of Americans’ income by decade’s end, up from 5.4% in 2008 and 3.1% in 1994. The extra $800 or so that the average person would spend on gas each year then would surely be better spent on something else–as long as it was discretionary.

Now just as the frog will eventually get the picture and jump out, we’re not condemned to slowly suffer from rising energy prices–we can do something about it. That includes discovering more oil, developing viable forms of alternative energy like wind and solar, and affecting the demand equation by boosting energy efficiency and energy storage. As editor of Cabot Global Energy Investor, I see three areas that are particularly worth keeping an eye on as a way to profit from the evolving energy market.

One is the boom in domestic oil and gas resources. I’m especially excited about the Bakken, the geological formation beneath the Dakotas and eastern Montana that may hold as much as 206 billion barrels of recoverable oil. If true it would equal 48 years of U.S. oil imports.

In our Energy Portfolio, we recently sold a producer that was focused on the region–Brigham Exploration–because it was acquired by Norway’s Statoil (NYSE:STO) for 35.50 a share, giving us a 32% profit in four months. That’s nice, but the Bakken is too impressive for us not to continue to have a hand in it. We added a small, fast-growing producer to our Energy Portfolio this month (I can’t tell you the name because we give our subscribers at least two weeks to buy before we think about disclosing recommendations). We’ll likely add another, larger producer to our portfolio soon.

Another area I think has big potential is energy storage. In particular, lithium-ion batteries, which will play a key part in giving hybrids and electric vehicles even greater ranges and make even traditional cars more energy efficient.

Recently we sold out of a long-time favorite I have mentioned before, Polypore (NYSE:PPO), which makes high-tech battery membranes. Its chart turned bearish and we decided it was time to take profits–a total of 135% return on our investment in 18 months. At the moment, I’m not thrilled with the universe of battery stocks besides Polypore, but I suggest that you take a look at the world’s largest miner of lithium, Sociedad Quimica y Minera (NYSE:SQM), a Chilean company we’re had success with before. The trading chart isn’t terribly bullish, and it’s a little pricey at 22 times 2012 earnings but it’s been attracting very good institutional buying action of late–a positive sign.

The third area of great interest to me as an investor right now is alternative fuels. Primarily, I believe natural gas has the potential to be a viable alternative to diesel in the trucking and industrial equipment sector. Already many ports, such as Long Beach, California, require trucks and equipment to be natural gas-powered, because the fuel burns far cleaner than diesel. Natural gas is also abundant in the U.S., relatively low-priced and its price isn’t affected terribly by international oil prices.

A leading firm in the production of natural gas engines is Westport Innovations (NASDAQ:WPRT), a Canadian firm that has a very profitable joint venture with truck engine maker Cummins as well as Volvo trucks, Weichai, the leading China heavy equipment maker, and others. While the company has focused on trucks and industrial equipment, it is now expanding into light trucks. Earlier this autumn, Westport inked deals to supply natural gas engines to the Ford (NYSE:F) F-series trucks and also finalized a venture with General Motors (NYSE:GM) to develop natural gas engines for GM’s light truck line.

The number of natural gas vehicles on the road worldwide has grown from about one million in 2000 to over 12 million in 2010, an annual growth rate of 26%. In North America, analysis firm Frost & Sullivan expects natural gas fueled trucks to grow to 8% of the region’s truck sales market by 2017, from 1% last year (currently, a natural gas truck costs 20% more than its diesel counterpart). According to the researchers, as long as the gallon equivalent of natural gas is $1.50 less than diesel prices, the extra upfront cost is worth paying. Of late, diesel has been averaging around $4 a gallon, while natural gas trucking firms have been paying $1.65 to $1.80 per gallon equivalent to fuel their vehicles. That’s a good price dynamic, one that will continues to help Westport grow its $200 million annual sales.

Source: Stocks For New-Energy Investors