Analyst: Ethanol Is Latest 'Fuel Cell' Craze

Last year may have been great for the energy sector, but so far 2007 is a different story. Oil prices fell to as low as the $50 range from $58.34 on Jan. 4, but they have stabilized a bit since then. The sudden dip has pushed OPEC to enforce a proposed 500,000 barrel a day cut in production, starting Feb. 1. Even though Apache, Exxon Mobil, Marathon Oil and Valero Energy all report earnings on Thursday, it’ll be too soon to predict what this downtrend means for energy stocks on the whole. To get a better idea of what investors should do, Michelle Caruso-Cabrera asked two analysts for their predictions for the coming year.

Michael Lynch works for Strategic Energy and Economic Research. He says the performance of energy stocks is based almost entirely on the price of oil, and he doesn’t think the market has hit a bottom just yet. There may be a pick-up in the third quarter, but over the next few months, “This is about as good as it gets,” he says. He’s not expecting oil to rise much above $55.

As for strategy for those already owning energy stocks, Lynch says it all depends on how risk averse investors are. There’s always a chance a sharp change in geopolitics could send prices north again. But at the same time, he doesn’t think oil will plummet to $30 either – most of the losses are probably out of the market by now, he says. But the key factor to watch will be how big funds play the sector. In a worst-case scenario, Lynch says, if these funds start to sell off oil in large amounts, prices could drop to $40 by the summer.

On the flip side, Jacques Rousseau of Friedman Billings Ramsey Group believes that oil will get a boost from gas and diesel. His theory rests on the idea that the big driver for oil prices is not inventory but a shortage of refined products such as gas and diesel. As we head into the time of year when refineries go down for maintenance, supplies will dip.

“We think that the pressure on gasoline and diesel is going to pull up oil price with it,” he says.

Rousseau says that when the Department of Energy releases inventory on Wednesday, we’ll see two months of continued decreasing supply, and that has a lot to do with refineries and maintenance. His picks for the sector are Tesoro and Valero Energy.

Speaking to the latest craze over ethanol, Lynch likens it to the fuel cell mania of the late ‘90s. “We’re still waiting for fuel cells to be in cars,” he says.

Rousseau says the double volatility in ethanol (which results from both oil and corn prices) will lessen and his predicted rise in crude prices will take the alternative fuel higher as well. He also cites speculation that the U.S. may plant 10% more corn next year. His picks in the sector are Aventine Renewable Energy Holdings and Verasun Energy.

The price of crude on the NYMEX is up to $56.22 as of Tuesday afternoon. Oil prices have dropped $24 since last July.

Analyst disclosure: Friedman Billings Ramsey Group is an investment banking client for AVR.