All of this means that energy companies are still preferred despite their massive gains. What size?

The Energy Select Sector SPDR Fund XLE,
+1.30%
was recently up 57% this year compared to 24% for the S&P 500 SPX,
+ 0.37%
and 18.7% for the Dow Jones Industrial Average DJIA,
+ 0.56%.

And the 12 stocks I singled out in this energy column a year ago are up 90%.

Here are four reasons the energy business will continue to operate, and 11 names to consider now.

Read: US oil producers pose ’emerging threat’ after OPEC + defies calls to speed up production increases

1. Brrr… a cold winter

Joe Bastardi of WeatherBELL Analytics predicts that a quick start to winter will result in below normal temperatures in November and December. January to March is a more difficult call. But WeatherBELL predicts that population-weighted heating degree days will rise to 3,924 November-March, above the 3,855 average over the past 10 years.

“We expect a colder than normal winter for much of the United States,” Bastardi said.

Heating degree days measure how well average temperatures are below 65 degrees, the temperature below which buildings should be heated.

This will drive up energy prices, but especially natural gas.

“If we have a colder than normal winter, we’re going to have double-digit natural gas prices,” says Ben Cook, who manages the Hennessy BP Energy Transition HNRIX,
+ 1.71%
funds.

Natural gas recently traded at $ 5.60 per million British thermal units (MMBtu).

“It’s very likely that we will see spikes during peak demand this winter,” Cook said.

This will put an offer under natural gas stocks (see below). Cook is worth listening to because his fund outperforms its energy category by 4.4 percentage points annualized over the past five years, according to Morningstar.

2. Pack your bags

Domestic travel in the United States is almost back to normal. But international travel still has a long way to go.

“This is the only area of ​​global oil demand that could improve in the near term,” Cook said. It’s at 25% of pre-pandemic levels, so it has plenty of room to bounce back amid concerns about the ease of Covid.

The more trips, the colder the winter, will create a demand for “middle distillates,” which include jet fuel (kerosene) and heating oil. Global oil demand has already rebounded above 100 million barrels per day (BPD), pre-Covid levels. But these trends could push Brent past $ 100 a barrel in the near term, according to Francisco Blanch, a commodities strategist at Bank of America. Brent recently traded at $ 80 a barrel.

3. The ESG effect

Carbon emissions make energy a difficult sector to own. Environmental, social and governance (ESG) funds are the most underweighted energies, and many pension funds have banned the sector. Less capital means less capital expenditure, points out Savita Subramanian, Bank of America strategist.

The low production of wind and hydro power combined with a booming demand from the industrial sector exacerbates the problem.

“As a result, tight energy markets could persist for a number of years until the planet shifts to a green energy economy,” Blanch said. “A multi-year increase in crude oil prices is now in the cards.”

In particular, the Organization of the Petroleum Exporting Countries (OPEC) has low reserve capacity.

How do we know? OPEC countries have not respected production quotas, although they often cheat. This makes you wonder how much reserve capacity OPEC actually has. Even if OPEC has the four or five million barrels a day of spare capacity it claims, in a year it will be done with the currently planned monthly production increases of 400,000 BPD, says Cook.

The International Energy Agency estimates that the oil industry needs to invest around $ 365 billion a year to keep pace. Last year, capital spending (capex) fell to $ 350 billion. It hasn’t bounced back in 2021, and it probably won’t bounce back in 2022 either.

4. The substitution effect

Natural gas and coal have become so expensive, especially in Asia and Europe, that many large energy consumers are switching to oil instead. This stimulates demand and boosts oil price gains, Blanch says.

The bottom line

Because of these factors, Bank of America recently increased its price forecast for Brent by around $ 10 each, to $ 85 for all of 2022. But the bank predicts that oil could reach $ 100 to $ 120 on barrel over the next six to eight months.

On similar supply and demand issues, Morgan Stanley analyst Martijn Rats recently raised his Brent forecast to $ 95 in the first quarter of next year. Citing the growth of world population and wealth, he predicts that global energy consumption per capita will increase by 23% by 2040.

All of this means that earnings and cash flow estimates need to be revised upwards for energy stocks, which should push them higher, Cook says.

Outlook for natural gas

Like oil, natural gas has taken off and will only increase when we enter the heating season. Especially since we risk having a colder than normal winter, according to WeatherBELL.

This means that the natural gas stocks, below, have more room to function. But consider selling in force over the next few months. Natural gas prices are likely to decline as heating demand declines in the spring and summer, predicts Bank of America.

“We believe the current winter risk premium has reached excessive levels,” Blanch said.

Production will increase, also exerting downward pressure on prices. The bank expects Henry Hub gas prices to average $ 3.45 per MMBtu in 2022, down from around $ 5.60 today.

Actions

Among large caps, Cook at Hennessy Funds favors Exxon Mobil XOM,
+ 0.95%
and Chevron CVX,
+1.08%.
He also likes Pioneer Natural Resources PXD,
-0.28%,
a low-cost shale producer in the Permian, and Comstock Resources CRK,
+ 2.54%,
a pure game on natural gas.

Doug Leggate of Bank of America recognizes Exxon Mobil and Hess HES,
+ 0.51%
as particularly inexpensive. He also likes Occidental Petroleum OXY,
-0.98%
and APA APA,
+ 2.82%
because they are lightly hedged, which means they benefit more from rising energy prices.

I suggested Continental Resources CLR,
+ 3.31%
also low at $ 9 in my stock letter last year. (You can find the link in my bio below.) I still love it, especially if it drops to $ 42.20, my current purchase limit. The stock recently traded at $ 44.60.

Also consider liquid natural gas (LNG) companies. They freeze natural gas and ship it from low cost places to high priced places around the world. LNG is in high demand in Europe and Asia as these regions shift away from coal due to pollution and climate change.

“The market is underestimating the size and speed of coal replacement in Asia,” said Devin McDermott, analyst at Morgan Stanley. “Although renewables are growing, they cannot fill the void, leaving the way for higher and longer demand for LNG. ”

Morgan Stanley predicts that the demand for LNG will increase by 50% by 2030. He distinguishes Cheniere LNG,
+ 2.13%,
NEXT Decade NEXT,
+ 3.02%
and Royal Dutch Shell RDS,
+ 2.81%,
as preferred LNG names.

Risks

1. As swing producers, American frackers have a habit of borrowing too much to drill more in order to make quick money. They are over-indebted and in trouble. It’s a risk, but we might not see a repeat. They have a new respect for shareholders. They are now prioritizing the return of capital by increasing dividends and share buybacks, and reducing levels of risky debt.

“What’s different now is that the behavior of the company is aligned with the interests of shareholders and that’s huge,” says Cook. “As long as the industry is disciplined when it comes to capital, I think energy stocks will continue to work. The source of the discipline is having a story that only hit their heads when they go up. their expenses usually explode in their face.

This could change when OPEC officially runs out of spare capacity. This would reduce the risk of OPEC’s output spike to gain shares. That could happen a year from now with current increases in OPEC’s production rate, Cook says. But it’s far.

2. Iranian production is back. That could reduce the price of oil by $ 5 to $ 10 a barrel, according to Bank of America.

3. Helima Croft, commodities strategist at RBC Capital Markets, says another risk is that President Biden will release crude from the strategic oil reserve to fight rising oil and gasoline prices, which create political issues. This would upset energy stocks, but it would only be a temporary solution.

Michael Brush is a columnist for MarketWatch. At the time of publication, he owned XOM, CLR, and NEXT. Brush suggested XOM, CVX, PXD, CRK, HES, OXY, APA, CLR, LNG, NEXT, and RDS in his stocks newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.