Profit from a stupid energy policy

By Jim Jubak

House Speaker Nancy Pelosi called the energy bill Congress passed and President Bush signed in December "groundbreaking." Now that oil has hit $100 a barrel, other descriptions -- laughably inadequate, cruel hoax, stupidity incarnate -- come to my mind.

I do, however, have one good thing to say about this law, which combines the worst of Washington special-interest politics with the desire of the average politician to avoid rocking the boat while seeming to do something for "the people." It is a superb guide to making money in the energy sector over the next five years:

Buy oil-service stocks, coal producers and transporters, movers of water and, surprisingly, producers of electrical cable, owners of pipelines and solar stocks.

Today, I'm going to explain the provisions of the bill and give you five picks for the first two segments, oil-service companies and coal producers and transporters. I'll save my plays on water, electrical cable and pipelines for my next column and give solar stocks a column of their own to round out the series.

New energy requirements

The Energy Independence and Security Act, to use its bloated title in Washington-speak, does the following:

• It requires cars and light trucks sold in the United States to deliver a fleetwide average of 35 miles per gallon from the current 27.5 miles per gallon by 2020.

• It sets new energy-efficiency standards that would phase out incandescent light bulbs in favor of compact fluorescents and other energy-efficient bulbs by 2014.

• It mandates an increase in the production of biofuels, such as corn-based ethanol, to 36 billion gallons by 2020.

• It throws a small barrel of subsidies, mostly for research, at energy technologies -- $90 million a year for advanced battery research, for example.

• It requires the Department of Energy to study a grand range of topics from the durability of engines using biodiesel to the barriers to greater use of biogas.

In other words, aside from the rather timid increase in miles per gallon by 2020 -- European clean-diesel cars can easily get 40 miles to the gallon already -- this is a recipe for doing nothing meaningful in the next five years.

Everyone, even an ethanol fanatic, knows we aren't going to get to 36 billion gallons of corn-based ethanol by 2020. Competition for corn supplies for fuel and food has already pushed up corn prices to the point where making ethanol is barely profitable. And that's with production running at 6.4 billion gallons of corn-based ethanol and consuming just 20% of the corn harvest in 2007. Most estimates show corn-based-ethanol production peaking at somewhere near 15 billion gallons a year.

Fuel technologies in the works

And where's the rest of that 36 billion gallons of biofuels to come from? From technology that would turn switch grass or wood chips or other sources of cellulose into ethanol or some other fuel.

The problem is that this technology isn't quite ready for prime time. Range Fuels, with funding from venture capitalists and $76 million from the Department of Energy, has begun work in Georgia on what it calls the country's first commercial-scale cellulose-to-ethanol plant, using wood chips and forest residue to produce ethanol. Other government grants awarded Jan. 3 -- a total of $385 million -- went to Iogen Biorefinery Partners, Abengoa Bioenergy Biomass of Kansas, Alico, BlueFire Ethanol and Poet (formerly Broin).

It's hard to find a public company on the cutting edge of the future of biofuels to invest in. There are a few small publicly traded companies working on developing better enzymes for turning cellulose into fuel. They're small and volatile, so check them out carefully. One you might consider if you're hankering after an investment in this sector is Verenium (VRNM, news, msgs). This small biotech has research agreements with DuPont (DD, news, msgs), Bunge (BG, news, msgs) and Cargill. Caveat emptor: The stock trades for less than $10, and the company is projected to lose money again this year.

Continued: Years from reality

Years from reality

Getting to a cellulose-based biofuels industry that can provide billions of gallons of competitively priced fuel to the transportation market is at least five years away, most in the field agree. Others say the schedule is more like 10 years. The technology needs to be improved to bring costs down to something like the $1.50 a gallon that corn-based ethanol costs to produce. And the industry will have to solve the problem of how to collect enough bulky biomass from sources such as forests and grasslands to feed a processing plant.

If you accept that the United States faces real problems -- whether you see those as global climate change, a threat to national security from a dependence on imported oil or simply painfully high prices of heating oil and gasoline -- then a national energy policy of delay may strike you as insane.

But delay does create winners in these two segments of the energy industry:

Winner No. 1

Delay means the United States will continue to consume an increasing amount of oil every year. That will help keep global supply tight in 2008 and, Wall Street analysts project, keep oil prices above $80 a barrel, on average, this year. Oil prices averaged around $74 a barrel in 2007.

With $80 oil, 2008 will see big increases in capital budgets from the international oil majors and from the state-owned oil companies that now control about 80% of global oil reserves. In December, Lehman Bros. (LEH, news, msgs) projected that the global oil industry's capital spending would climb by 11% this year, with the bulk of the increase coming outside North America. That extends the boom times for drillers and oil-service companies for at least another year and makes them a major winner from a U.S. energy policy of delay.

My three picks in this sector for 2008 are FMC Technologies (FTI, news, msgs), Weatherford International (WFT, news, msgs) and Oceaneering International (OII, news, msgs):

• FMC Technologies is in the process of spinning off its food-technology and airport-systems businesses to shareholders by mid-2008. What will remain is a tightly focused energy company with a 40% to 45% share of the market for subsea systems that control the flow of oil and gas from ocean floors to floating production facilities, fixed platforms or onshore storage systems. The company's expertise in oil production at depths of more than 1,000 feet assures FMC a big share of the hottest trend in new oil production.

• Weatherford International has gone hard after new business in the Caspian Sea basin, the Middle East and North Africa. As a result, sales outside North America climbed to 44% of total revenue in 2006 and to 50% of revenue in the third quarter of 2007.

• Oceaneering International specializes in deep-water and ultradeep-water equipment, including remotely operated vehicles (31% of revenue) and the connections needed to complete subsea drilling operations. The company has a dominant position on the 74 deep- and ultradeep-water rigs in operation, and with 65 more of the rigs scheduled for delivery from now through 2011, it is looking at a major expansion of its market opportunities. Day rates for remotely operated vehicles continued to climb in 2007 -- they rose 15% in the third quarter from the same period in 2006 -- and the 11% increase in oil industry capital spending forecast for 2008 should keep rates climbing.

Winner No. 2

The high price of oil makes replacing oil with coal an economic no-brainer. Environmentally, coal is a big problem, since producing a ton of oil from coal requires the use of five to 18 tons of water and releases seven to 10 times as much carbon dioxide as does refining oil.

But the U.S. energy policy of delay has left a big window open. The possibility that a future global agreement on climate change would restrict building of new coal-fired power plants or new coal-to-oil facilities has unleashed a rush to build, especially in Asia.

China Shenhua Energy (CUAEF, news, msgs) will start China's first large-scale coal-to-oil plant in 2008 with an initial output of 20,000 barrels a day. By 2030, the International Energy Agency projects, China will produce 750,000 barrels a day from coal. India is getting in on the act, too, with talks under way about setting up the country's first plant.

Continued: 2 sector picks and more

My two picks in this sector for 2008 are Joy Global (JOYG, news, msgs) and Burlington Northern Santa Fe (BNI, news, msgs):

• Joy Global makes equipment that powers the coal-mining boom and is one of the few survivors of a 20-year slump in the mining industry. And in the current boom, these survivors have huge pricing power. By the end of December, Joy Global had sold out its manufacturing capacity for mining shovels for the fiscal year that ends in October 2008. Fiscal 2009 capacity is completely booked, and the company is taking orders for 2010. (By going after the maker of the equipment, you also get exposure to other energy plays, such as Alberta's oil sands.)

• Burlington Northern has the most exposure to coal of any of the North American railroads, thanks to its huge share of the market for transporting coal from Wyoming's Powder River Basin. In 2006, hauling coal accounted for 20% of the company's revenue and 35% of its profits. (An additional 17% of revenue came from moving agricultural products, so this stock is a twofer.)

These five picks are obvious beneficiaries of the U.S. energy policy of delay, but there's another, less obvious side to the story. A government policy of delay that guarantees prices of $80 a barrel or better encourages the market economy to invest in present production, but it also pretty much guarantees that oil prices will remain high enough for long enough to encourage the market economy to invest in future trends.

• Talk back: What stocks will benefit from pricey oil?

In my next two columns, I'll take a look at where the market economy thinks the future of energy is going and how you can profit from those trends.

Updates to Jubak's Picks

Buy Weatherford International (WFT, news, msgs): The oil-service and oil-equipment sector outperformed the market in 2007, gaining 45%, and I think it's likely to be a winner again in 2008.

I'm going to take advantage of the pullback in oil-service stocks to upgrade Jubak's Picks by adding shares of Weatherford to replace my position in Tenaris (TS, news, msgs).

Tenaris has big exposure to the slow-growing North American drilling sector through its acquisition of U.S. steel-tube maker Maverick Tube, while Weatherford has gone hard after new business in the Caspian Sea basin, the Middle East and North Africa. Weatherford's sales outside North America climbed to 44% of total revenue for 2006 and to 50% of revenue in the third quarter of 2007.

In December, Lehman Bros. (LEH, news, msgs) projected that the global oil industry's capital spending would climb by 11% in 2008, with the bulk of the increase coming outside North America, so Weatherford has picked the right market. Wall Street is not projecting any slowdown in earnings growth for the stock: Estimated 2007 earnings growth of 31.6% is expected to be followed by 2008 growth of 31.8%.

(Note: Weatherford's participation in the Iraq oil-for-food program is being investigated by the U.S. Department of Justice and the Securities and Exchange Commission. At issue in part of the investigation is the alleged embezzlement and improper use of $175,000 at a European subsidiary that may have been used to make payments to government officials in Europe and elsewhere.)

As of today, I'm adding the shares of Jubak's Picks with a target price of $74 a share by July 2008.

Sell Tenaris (TS, news, msgs): The bulk of the growth in the oil-drilling/oil-equipment sector will come from outside the North American market in 2008. That means the October 2006 purchase of Maverick Tube by Tenaris, a move to grab more share in the North American market, was a long-term strategic coup that in the current market carries, unfortunately, significant short-term costs for investors.

As of today, I'm selling this position out of Jubak's Picks with a 10% loss since I added it to the portfolio on Dec. 8, 2006. (Full disclosure: I will sell my personal position in Tenaris three days after this column is posted.)

Sell Marriott International (MAR, news, msgs): When I added this stock to Jubak's Picks way back in November 2007, I thought it would be possible to navigate the rough seas in the U.S. economy and financial markets with a stock like this where the story was international growth. But the market clearly doesn't care about Marriott's opportunities in the midprice sector of the Chinese hotel industry. It just sees a domestic hotel operator that will go through tough times with a U.S. economic slowdown.

I still like the long-term story here: The company will open its first Courtyard by Marriott in Hong Kong in December and has just announced that it will build 20 more hotels in the country. And China isn't the only overseas growth market Marriott is tackling. About 50% of the company's 115,000 planned new rooms will be outside the U.S. But in the current stock market, it's hard to get anyone interested in a long-term story like this.

As of today, I'm selling these shares out of Jubak's Picks with a 20% loss since I added them Nov. 2.

Developments on past columns

"3 hot sectors where shares are scarce": As of today, I'm raising my target price on Yara International (YARIY, news, msgs) to $54.60 a share by March. At the end of November, the company told investors to expect $125 million to $160 million in cost savings, 7% to 9% of sales, in the company's October 2007 acquisition of Finnish phosphate fertilizer producer Kemira GrowHow.

The deal included Kemira's unopened phosphate mine at Sokli, Finland. Kemira had delayed opening the mine because of low world phosphate prices, but the price has doubled in the past year, and Yara is considering opening the mine, with its potential to produce 1.5 million metric tons of phosphate rock concentrate a year for 20 years. Fertilizer demand in the company's key markets in Latin America and India will continue to grow at double-digit rates for at least the next three years, the company estimates. Management has set a target of growing global market share to 10% from the current 7% in the next five to seven years.

(Full disclosure: I own shares of Yara International in my personal portfolio.)

"Natural gas? Play the Rocky Mountain high": I added Ultra Petroleum (UPL, news, msgs) to Jubak's Picks on Sept. 21, 2007, because the new Rocky Mountain Express natural-gas pipeline, expected to go into service in early 2008, would enable natural-gas producers in the Rocky Mountain region, the fastest-growing source of natural gas in the United States, to finally get their product out of the relatively small local market and into the bigger markets of the eastern U.S. That would gradually wipe out a discount that saw natural gas selling for $3.37 per million cubic feet less in Wyoming than in Louisiana.

Well, the Western stage of that pipeline, Rex-West, is set to open for service just about on time Feb. 1. Virtually all pipe had been bent as of mid-December, and 98% had been welded. Hydrostatic testing had been completed on 56% of the line. Pipeline operators have received commitments from natural-gas producers, including Ultra Petroleum, for almost all of the pipeline's capacity of 1.8 billion cubic feet per day. A second stage, expected to start partial service in December 2008 and full service in June 2009, will deliver gas to Ohio.

As of today, I'm raising my target price for Ultra Petroleum to $85 a share by October 2008.

(Full disclosure: I own shares of Ultra Petroleum in my personal account.)

Meet Jubak at The Money Show

MSN Money's Jim Jubak will be among more than 120 investment and finance experts sharing buy and sell advice at The World Money Show in Orlando, Fla., Feb. 6-9. Invest four days dedicated to planning and refining your portfolio by attending the event's more than 320 workshops and panel presentations.

Admission is free for MSN Money readers. To sign up, call 1-800-970-4355 and mention priority code No. 009554, or register online.Editor's note: Jim Jubak, the Web's most-read investing writer, normally posts a new Jubak's Journal every Tuesday and Friday. Please note that recommendations in Jubak's Picks are for a 12- to 18-month time horizon. For suggestions to help navigate the treacherous interest-rate environment, see Jubak's portfolio of Dividend Stocks for Income Investors. For picks with a truly long-term perspective, see Jubak's 50 Best Stocks in the World or Future Fantastic 50 Portfolio. E-mail Jubak at jjmail@microsoft.com.

At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Joy Global, Tenaris, Ultra Petroleum, Verenium and Yara International. He did not own short positions in any stock mentioned in this column.