Will the Energy Crisis Burn You?

Rising oil prices will have a dramatic impact on consumers, investors, and businesses this season. Who will profit or lose?

THIS PAST YEAR, THE WORLD HAS WITNESSED A DRAMATIC surge in energy prices. Reduced supplies, refinery capacity, tensions in the Middle East, and strong demand pushed up crude oil prices, which were as low as $10 per barrel in 1998, to a 10-year high of $37.80 in September.

As late as January of this year, California electricity suppliers, Southern California Edison and Pacific Gas & Electric (PG&E) declared that they were close to bankruptcy because of the skyrocketing cost of wholesale power. Edison said it lost $2.64 billion since last summer because of its inability to pass along mounting electricity costs to customers.

In response to this crisis, the California Public Utilities Commission raised electricity rates by 9% for residential customers of Edison and PG&E.

Likewise across the country, the higher crude oil prices have fueled a rise in U.S. retail gasoline, stunning consumers last spring when prices shot up to an alarming $1.50 or more per gallon. The high oil prices and concern about adequate supplies led President Clinton to release 30 million barrels of crude oil from the country's emergency reserve in September. The Organization of the Petroleum Exporting Countries (OPEC) increased output four times in 2000 in an effort to reduce prices, but to no avail.

Adding to the fray is the weather. The National Weather Service says that winter 2001 is one of the chilliest in the past few years, putting a strain on natural gas and heating oil supplies. According to the American Gas Association, U.S. inventories of natural gas, which are used to heat 70% of American homes, were 9.1% lower in November than for the same period in 1999, with gas prices rising to a 10-year record of $6.61 per British thermal unit. Analysts expect the gas deficit to widen throughout 2001, given predicted weather conditions.

Rising fuel costs can be bad news for consumers and enterprise, but investors holding energy stocks just might experience a boon to their portfolio.

CONSUMERS AND THE CRUNCH

With the upturn in energy prices, keeping fuel costs down will be even more important. But your pocket doesn't have to get burned.

Despite Americans' appetite for flashy sport utility vehicles (SUVs), you might want to consider a more fuel-efficient vehicle the next time you go to a car dealer. A Consumer Reports (December 2000) cost analysis showed that the sport utility Ford Excursion had an annual fuel bill of $2,345, assuming a gasoline price of $1.50 per gallon and annual mileage of 15,000. Conversely, a Toyota Camry's fuel bill under the same conditions was $885, a cost savings of $1,460.

When it comes to the home, take a proactive attitude in managing fuel costs. Many local utility companies offer customers cost-saving tips. New York's Consolidated Edison (www.coned.com) recommends that during the winter months customers take measures such as setting the thermostat at no higher than 68 degrees when you are up, and turning it down to 60 degrees when you go to bed or leave the house. The utility also suggests weatherproofing windows, among other remedies.

For heating oil, financial consultant Clifford A. Virgin III of Montclair, New Jersey, advises locking in a price for your fuel. "I locked in a cap rate of $1.13 per gallon of oil for the heating season (October to April). If the price of fuel goes down, I get the benefit of the lower price. However, if the price goes up, my rate will never be higher than $1.13. That's significant given that heating oil rates have recently been around $1.59 per gallon," he says. Virgin, who uses approximately 1,700 gallons of heating oil a year in his six-bedroom home, estimates his annual heating savings at about $800 if spot prices stay in the $1.59 range.

But regardless of price, Americans like to drive and they like to be warm. "Demand for fuel tends to be more price sensitive in Europe and other places than in the states. Our gross domestic product per capita is much higher and fuel is a much smaller percentage of our basket of costs," says energy analyst Martin Jacobs, executive director at Chicago-based Brinson Partners, an institutional investment management firm. "Europeans pay four times more for gasoline than Americans, due to higher taxes."

Richard B. Newman, head of the energy division in the Houston office of Germany-based Westdeutsche Landesbank, adds, "In the short-term, people do not change their habits. If the economy goes into a recession, it may take six months before there is a change in behavior. We have to drive and we must heat our homes," he says.

ENTREPRENEURS FEEL THE HEAT OF RISING OIL COSTS

"There used to be more of a partnership between companies and the car and truck manufacturers. When fuel costs went up, you went to the manufacturer and renegotiated your contract," says Charlie W. Johnson, president and CEO of Louisville, Kentucky-based Active Transportation (No. 4 on the 2000 BE INDUSTRIAL/SERVICE 100 list with $358 million in sales), a hauler of cars and large freight trucks to dealerships. "In today's environment, manufacturers look to maximize shareholder value. While we have gotten some relief from the manufacturers, we have not been able to fully recoup our higher fuel costs," he says.

Johnson predicts that Active's revenues will be down 35% to 40% for 2000, attributable to higher fuel costs and interest rates, which have decreased demand for large freight trucks by end users. The company has been forced to lay off 3% of its non unionized workforce and 40% of its unionized drivers over the past few months due to the decline in business.

Majority-owned start-up airlines National and Legend filed for reorganization under Chapter 11 bankruptcy in early December, blaming soaring fuel prices for their decision.

Some companies like Boston-based Grimes Oil Co. Inc. (No. 98 on the 1999 BE INDUSTRIAL/SERVICE 100 list with $24.6 million in sales), a distributor of petroleum products and natural gas, can more easily pass along higher oil prices. "We have not experienced a decline in sales volume due to higher prices. Margins on barrels of gas are low, so we must pass along higher fuel costs to our customers to stay in business," says Richard J. Carroll, executive vice president of Grimes. Carroll asserts that in the current climate for energy prices, some customers look to hedge their position by entering fixed-price contracts for petroleum for six to 12 months. "Should the price of fuel rise, it's a good thing, but if fuel prices go down, you get hurt. You really have to look at contracts over a five-year period," he says.

spell doom and gloom for everyone. Dick Griffey, chairman and CEO of African Development Public Investment Corp. and Dick Griffey Productions (No. 48 on the 2000 BE INDUSTRIAL/SERVICE 100 list with $61 million in sales), says, "The high oil prices are actually affecting our business in a positive way; since we are in the business of wholesaling crude oil, we have a fixed priced at which we purchase crude."

GETTING IN ON THE EBBS AND FLOWS OF THE MARKET

With crude oil and natural gas prices hitting record levels, the past year has brought strong performances for some energy sector stocks. According to a Goldman Sachs equity research report, energy stocks in all energy sectors 17, 2000: The diversified natural gas group rose 79.5%, exploration and production rose 65.1%, land drillers went up 61.5%, and large-cap oilfield services rose 28%. The aforementioned gains compare to a decline of 6.9% for the S&P 500 for the same period.

Given the current dynamics of the sector, some analysts are bearish on energy. "I wouldn't advocate investing in energy stocks at this time," says Jacobs. "Most of the increases in oil prices of the past year are already reflected in current share prices. You would essentially be entering the market at a high point." Jacobs cites low inventory levels, limited tanker capacity related to delivery of crude, as well as seasonal demand due to cold weather as factors driving oil price levels. "The factors driving the market are not sustainable. Oil prices should fall in early 2001, when the seasonal demand for oil decreases as the weather warms," he says.

The commodities markets already expect a softening in crude prices. Crude off prices for December traded at $33.24, while oil for March traded at $30.68. Some analysts contend that crude prices could decline even further depending on the state of the worldwide economy. In November, 50 oil consuming and producing countries met, reaching a consensus that oil prices of about $25 a barrel would be ideal for the market. Newman agrees that such a level is realistic and that the economy could sustain it.

Should you defy the bears and decide to jump into energy stocks at some point, Newman stresses the importance of understanding the components of the energy sector before doing so. "Like most industries, the energy sector in which you invest will depend on your aversion to risk. The integrated oil companies (Exxon Mobil, Shell, Texaco, Chevron, BP Amoco) have vertically integrated operations: oil and gas production, shipping and pipeline, refining and retail marketing (the entire supply chain). Because of the size and breadth of operations, their financial results tend to be more stable," he says.

According to Newman, independent oil companies like Apache, Anadarko, and Devon are typically only involved in exploration and production of resources, or upstream business. Their performance is dependent on the level of crude oil and natural gas prices, which have a history of volatility. There is more risk in being only in this sector.

The risk-return associated with holding independent oil stocks is reflected in the year-to-date (November 29) returns for Anadarko, up 82.44%; Apache, up 54.94%; and Devon, up 57.71%. "Refining and marketing companies such as Ultramar, Diamond Shamrock, Circle K, Tosco, and Lyondell are also only involved in one energy sector and therefore experience more volatility in earnings.

These companies are less impacted than the exploration and production companies by the level of prices but are impacted by the timing of the movements of supply. "Oil field services companies (Transocean, Global Marine, Noble Drilling, Ensco) are highly dependent on the integrated and independent companies for business. Their performance is a good barometer for expectations for the industry," says Newman.

Heating and Cooling Tips

* Set your thermostat as low as is comfortable in the winter and as high as is comfortable in the summer.

* Clean or replace filters on furnaces once a month or as needed.

* Clean warm-air registers, baseboard heaters, and radiators as needed;

* Place heat-resistant radiator reflectors between exterior walls and radiators.

* Use kitchen, bath, and other ventilating fans wisely. In just one hour, these fans can extract a houseful of warm or cool air. Turn fans off as soon as they have done their job.

* During the heating season, keep the draperies and shades on south-facing windows open during the day to allow the sunlight to enter your home, and closed at night to reduce the chill you may feel from cold windows.

* During the cooling season, keep the window coverings closed during the day to prevent solar gain.

* Close any unoccupied room that is isolated from the rest of the house, such as in a corner, and turn down the thermostat or turn off the heating for that room or zone. However, do not turn the heat off if it adversely affects the rest of your system.

* Look for high Annual Fuel Utilization Efficiency (AFUE) ratings and the Seasonal Energy Efficiency Ratio (SEER) on products. The national minimums are 78% AFUE and 10 SEER.

* Look for the ENERGY STAR[R] and EnergyGuide labels. ENERGY STAR[R] is a program of the U.S. Department of Energy (DOE) and the Environmental Protection Agency (EPA) is designed to help consumers identify energy-efficient appliances and products.

SOURCE: ENERGY EFFICIENCY AND RENEWABLE ENERGY NETWORK -- U.S. DEPT. OF ENERGY

For more tips visit www.eren.doe.gov/energy_savers

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