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Industry Structure

Showing structure of the primary-source energy industry with representative companies. Note comparison of financial metrics vs. companies in other industries, at the bottom of the table. Energy company profit margin tends to be quite volatile with the highs achieving notorious publicity and political attention, but averaged over either a short time period (a year, since seasonality has large effects on energy) or a long period, is lower profit margin (profit $ divided by operating cost $) than most other industries. Although the industry shows comparable growth (driven by overall GDP growth), PE is always lower probably because volatility makes short-term growth unpredictable so investment in this sector is the domain of investors with high risk tolerance and longer than average timeframes. Note that more than a few companies show negative earnings at the moment of this snapshot, demonstrating the degree of volatility in the industry. Here's a comparison of industries, from Yahoo! Finance along with a spreadsheet. (Note: this file will download as a .zip file. Change the file extension to ".xlsm" and open it in Excel.)

• Oil in particular is driven by politics and economics as much or more than by supply and demand. Here's an interview from Seeking Alpha describing trading behavior as of October 2009 you should be aware of, when investing in energy. Important points: Oil is an international commodity affected by trading and politics. Natural gas is less so because it is constrained by limited transport facilities, even though it is in many ways the more desirable fuel. Oil as an energy source is less-constrained by oil supply, than it is by refining capacity. Crude oil price is more driven today by financial players than it is by supply and demand. This is a worldwide phenomenon, not limited to the US. Nationalized oil supply outside of the US is definitely having an effect on US oil supply. Companies with exposure to E&P are likely to do well. Smaller-cap companies are likely to outperform integrated companies.
• Oil profits reported in the news are high in absolute dollar terms because volume of usage is very high. Look around you. Every car, house, factory, office building, streetlight, TV, computer, pump is powered every day using energy from one or more of these high-volume sources.
• Also note that several show negative profitability. Energy stocks typically have high beta, or volatility, with high short-term investment risk.
• Look at refiner metrics - it's a high-capital-expense business, with volatile margins. Also check refiner capital spending via the link, it's generally quite high. Although new refineries are constrained by siting and similar factors, existing refineries are continuously re-fitted, upgraded, and expanded. Environmental concerns favor use of high-grade light sweet crude in the US which is the most expensive and supply-constrained. Some refiners have fitted special equipment to process heavy sour crude.
• There are several types of coal, some suited to high-temperature industrial use, some have lower sulfur content than others, notably coal from the Powder River Basin in Wyoming. Some coal companies have greater concentration of these different types of coal, than do others.
• Railroad business is on the whole driven by coal (summer and winter), fertilizer and chemicals (summer, also related to natural gas). Listed below are railroads with routes covering PRB coal. The Association of American Railroads publishes a monthly and weekly Rail Time Indicators Report that provides interesting insight into the US economy. The September 2009 numbers show coal as 49% of YTD carloads, chemicals at 12%, agriculture (largely grain) at 13%, and minerals at 10% of US YTD carloads.
• Coal and natural gas commodities tend to trade together because utilities switch between them to use the lower-cost commodity to generate electricity. When there's demand for one, there's also demand for the other so company securities tend to trade together, both up or both down.
• Driving and air conditioning drive gasoline (therefore refiners), natural gas, and coal prices up in the summer. Winter weather drives heating oil (therefore refiners), natural gas and coal up in the winter. In fall and spring, energy usage tends to be down relatively, with corresponding effect on prices.
• Rigs, Drillers and Coal tend to be driven by worldwide and domestic contracts. Natural gas, Pipelines, Refiners, Utilities, Railroads tend to be driven by regional (therefore domestic) demand. Inter-regional transport of NG is typically by LNG, and LNG ports are quite constrained. O&G tend to have contracts to import from foreign sources, and the oil market is truly worldwide, so are driven also by foreign politics, rebel attacks, supply shortage, foreign competition etc.; and these factors may affect pricing of substitution commodities up or down.
• Inventory figures are released by the EIA Wednesdays for oil and distillates, and Thursdays for natural gas, at 1030 New York time. The relationship of these numbers to analyst expectations moves the market. The numbers may periodically be estimates. Numbers released at periods of high volatility may be revised in subsequent weeks. I'm just sayin'...
• Historically, there have been relationships among energy prices. Natural gas wellhead price is typically 11.4% of WTI (West Texas Intermediate crude oil).

Data is from Yahoo Finance, 22 August 2009, in $USD. WTI (West Texas Intermediate crude) is $74/bbl today, although that is the marginal price, not the average price of oil shipped today which was contracted at an earlier time. "ttm" stands for "trailing twelve months".