US Short Term Energy Outlook

Energy outlook, EIA expects the U.S. average refiner acquisition cost of crude oil to remain relatively flat, averaging about $100 per barrel in 2011 and 2012. The value of West Texas Intermediate (WTI) benchmark crude oil was about $11 per barrel below the U.S. refiner acquisition cost of crude oil in the third quarter of this year.

The forecast WTI price discount narrows to $8 per barrel by the fourth quarter of 2012, as rail and truck capacity is added to the region. EIA’s U.S. and world economic growth assumptions have been lowered from last month’s Outlook. World oil-consumption-weighted real GDP grows by 3.1 percent in 2012, compared with 3.5 percent in the previous Outlook. EIA projects that average household heating expenditures for heating oil and propane will increase by 10 percent and 9 percent, respectively, this winter (October 1 to March 31) compared with last winter. Average expenditures for households that heat with oil or propane are forecast to be higher than in any previous winter. In contrast, natural gas and electricity expenditures are projected to remain close to last year’s levels. Regular-grade gasoline retail prices have fallen by 46 cents per gallon from their peak monthly average this year of $3.91 per gallon for May to $3.45 per gallon for October. This drop in prices results from falling crude oil prices as well as the normal seasonal decline in consumption and the switch in production from summer-grade gasoline to lower-cost winter-grade gasoline.

EIA projects gasoline retail prices to continue to decline, albeit slightly, through the end of the year. Natural gas working inventories ended October 2011 at an estimated 3.8 trillion cubic feet (Tcf), about 1 percent below the same time last year. The projected Henry Hub natural gas spot price averages $4.09 per million British thermal units (MMBtu) in 2011, $0.30 per MMBtu lower than the 2010 average, and $4.13 per MMBtu in 2012. Regional turmoil, particularly in Syria and Yemen, exerts additional pressure on the non‐OPEC outlook and on global oil prices. EIA revised Brazil’s liquids fuels production forecast downward for both 2011 and 2012 by 140 thousand bbl/d and 90 thousand bbl/d, respectively. The revisions are due to the decrease in projected ethanol production resulting from a poor sugar cane harvest and reduced investment. However, EIA expects that Brazil’s crude oil production will continue to increase through the forecast period.

OPEC Supply.

While forecast OPEC non‐crude liquids production, which is not subject to production targets, is expected to increase by 0.4 million bbl/d in 2011 and by 0.5 million bbl/d in 2012, EIA expects OPEC crude oil production to remain flat in both 2011 and in 2012, after having grown by 0.7 million bbl/d in 2010. Libyan oil exports resumed at the end of September, averaging about 0.2 million bbl/d. EIA expects Libyan crude oil exports to rise to 0.35 million bbl/d during the first quarter of 2012 and to 0.8 million bbl/d by the end of 2012, compared with pre‐disruption exports of 1.5 million bbl/d. OPEC surplus crude oil production capacity falls from 3.5 million bbl/d in the fourth quarter of 2010 to a projected 3.0 million bbl/d in the fourth quarter of 2011, but then increases to 4.0 million bbl/d in the fourth quarter of 2012, as Libyan production capacity comes back on line, freeing up capacity in other OPEC countries (OPEC Surplus Crude Oil Production Capacity Chart).

OECD Petroleum Inventories.

EIA expects that OECD commercial inventories will decline in both 2011 and 2012. However, because of declining consumption, days of supply (total inventories divided by average daily consumption) falls slightly, from 57.7 days to 57.4 days between the fourth quarters of 2011 and 2012 (Days of Supply of OECD Commercial Stocks Chart).

Crude Oil Prices.

West Texas Intermediate (WTI) crude oil spot prices fell from an average of $110 per barrel in April to $86 per barrel in August, and remained near this level through October (West Texas Intermediate Crude Oil Price Chart). EIA has revised the projected oil price paths slightly upward from last month’s Outlook. EIA expects that the U.S. refiner average crude oil acquisition cost will average $100 per barrel in 2011 and 2012, slightly higher than the projections of $99 per barrel and $98 per barrel for 2011 and 2012, respectively, in the previous Outlook. For most of the last 30 years, WTI has traded at a premium over the average U.S. refiner acquisition cost of crude oil. However, the growth in crude oil supply, particularly from Canada and North Dakota, to the midcontinent region where WTI is traded, has not yet been matched by increases in transportation capacity out of the Midwest to the refining centers, such as the Gulf Coast. This transportation bottleneck contributes to the large price discount for WTI relative to other U.S. and world crude oils. After reaching a record price discount in the third quarter of this year, the discount for WTI is now expected to diminish modestly as the flow of crude oil out of the mid‐continent region increases. Consequently, the projected U.S. refiner acquisition cost of crude oil, which averaged $11 per barrel above WTI in the third quarter of this year, narrows to $8 per barrel above WTI by the fourth quarter of 2012, as rail and truck capacity is added.

Energy price forecasts are highly uncertain (Market Prices and Uncertainty Report). WTI futures for January 2012 delivery during the 5‐day period ending November 3 averaged $93 per barrel. Implied volatility averaged 39 percent, establishing the lower and upper limits of a 95‐percent confidence interval for the marketʹs expectations of monthly average WTI prices in January of $72 per barrel and $121 per barrel, respectively. Last year at this time, WTI for January 2011 delivery averaged $85 per barrel and implied volatility averaged 31 percent. The corresponding lower and upper limits of the 95‐percent confidence interval were $69 per barrel and $103 per barrel.

U.S. Crude Oil and Liquid Fuels

U.S. Liquid Fuels Consumption. Projected total U.S. liquid fuels consumption in 2011 falls by 250 thousand bbl/d (1.3 percent) (U.S. Liquid Fuels Consumption Chart). Motor gasoline consumption accounts for most of the projected decline for the year, shrinking by 220 thousand bbl/d (2.4 percent). EIA expects total liquid fuels consumption to increase by 110 thousand bbl/d (0.6 percent) to 19.0 million bbl/d in 2012. Projected motor gasoline and distillate consumption rise by 40 thousand bbl/d (0.5 percent) and 30 thousand bbl/d (0.7 percent) in 2012, respectively, as highway travel and the U.S. economy show modest growth.

U.S. Liquid Fuels Supply and Imports. Domestic crude oil production increased by 110 thousand bbl/d in 2010 to 5.5 million bbl/d. Production increases by a further 210 thousand bbl/d in 2011, and by 240 thousand bbl/d in 2012 (U.S. Crude Oil and Liquid Fuels Production Chart). This rising trend in production is driven by increased oildirected drilling activity, particularly in on‐shore shale formations. Liquid fuel net imports (including both crude oil and refined products) fell from 57 percent of total U.S. consumption in 2008 to 49 percent in 2010 because of rising domestic production and the decline in consumption during the economic downturn. EIA forecasts that liquid fuel net imports share of total consumption will decline to 45 percent in 2011.

U.S. Crude Oil and Petroleum Product Inventories. Distillate fuel oil stocks ended October 2011 at an estimated 143 million barrels, down 19 million barrels from the same time last year and 5 million barrels below the average for that month between 2006 and 2010 (see This Week In Petroleum, Nov. 2, 2011). Total motor gasoline stocks at the end of October 2011 were an estimated 209 million barrels, down 1 million barrels from last year but 5 million barrels higher than the previous 5‐year average for that month. Projected total distillate and motor gasoline inventories at the end of 2012 will average about 3 million barrels and 4 million barrels higher, respectively, than their previous 5‐year averages (U.S. Gasoline and Distillate Inventories Chart). Commercial crude oil inventory levels ended October 2011 at an estimated 340 million barrels, 28 million barrels below last year but 8 million barrels higher than the previous 5‐year average for that month. Projected commercial crude oil stocks are gradually drawn down to 317 million barrels by the end of 2012, close to their 5‐year average (U.S. Crude Oil Stocks Chart).

U.S. Petroleum Product Prices. EIA forecasts that the annual average regular‐grade gasoline retail price, which averaged $2.78 per gallon in 2010, will increase to an average of $3.54 per gallon in 2011, before declining to an average $3.46 per gallon in 2012 (U.S. Gasoline and Crude Oil Prices Chart). The higher retail prices in 2011 reflect not only the higher cost of crude oil but also changes in the average U.S. refinery gasoline margin (the difference between refinery wholesale gasoline prices and the average cost of crude oil). The average U.S. refinery gasoline margin increases from $0.34 per gallon in 2010 to $0.48 per gallon in 2011, then declines to $0.42 per gallon in 2012. The forecast narrowing of the WTI crude oil price discount to other crude oils should lower average refining margins next year. EIA expects that on‐highway diesel fuel retail prices, which averaged $2.99 per gallon in 2010, will average $3.84 per gallon in 2011 and $3.79 per gallon in 2012 (U.S. Diesel Fuel and Crude Oil Prices Chart).

Natural Gas

U.S. Natural Gas Consumption. EIA expects that total natural gas consumption will grow by 1.7 percent to 67.1 billion cubic feet per day (Bcf/d) in 2011 (U.S. Total Natural Gas Consumption Chart). Rising use of natural gas in the industrial and electric power sectors accounts for most of the increase in total consumption this year, with projected growth rates of 2.0 percent and 1.5 percent, respectively. Projected total natural gas consumption increases by 1.1 percent in 2012 to 67.9 Bcf/d, compared with a projected level of 67.7 Bcf/d in last month’s Outlook. Higher projections of residential and commercial consumption account for much of this change in the forecast, driven by the 1.1 percent increase in heating degree‐days from 2011 to 2012.

U.S. Natural Gas Production and Imports. EIA expects U.S. marketed natural gas production to average 65.6 Bcf/d in 2011, a 3.8‐Bcf/d (6.1 percent) increase over 2010. All of this growth comes from higher onshore production in the lower 48 States, which more than offsets a year‐over‐year decline of 1.0 Bcf/d (17 percent) in the Federal Gulf of Mexico (GOM). EIA expects that total marketed production will continue to grow in 2012, but at a slower pace, increasing 1.3 Bcf/d (2.0 percent) to an average of 66.9 Bcf/d d (U.S. Total Natural Gas Production and Imports Chart). Drilling activity has been resilient despite lower natural gas spot and futures prices. According to Baker Hughes, the October 28 rig count was 934 active drilling rigs targeting natural gas, higher than this year’s low of 866 on May 20 and higher than last month. If drilling continues to increase, production could grow more than expected in 2012.

Growing domestic natural gas production has reduced reliance on natural gas imports and contributed to increased exports. EIA expects that pipeline gross imports of natural gas will fall by 6.7 percent to 8.5 Bcf/d during 2011 and by another 1.4 percent to 8.3 Bcf/d in 2012. Projected U.S. imports of liquefied natural gas (LNG) will fall from 1.2 Bcf/d in 2010 to 0.9 Bcf/d in 2011 and to 0.7 Bcf/d in 2012. Pipeline gross exports to Mexico and Canada are expected to average 4.1 Bcf/d in 2011 and 4.2 Bcf/d in 2012, compared with 3.1 Bcf/d in 2010.

U.S. Natural Gas Inventories. Working natural gas in storage ended October at an estimated 3.8 Tcf (U.S. Working Natural Gas in Storage Chart). EIA expects that working natural gas inventories will total about 1.8 Tcf at the end of March 2012, the end of the winter heating season. This would represent a withdrawal of 2.0 Tcf over the upcoming heating season, compared with a withdrawal of 2.3 Tcf last season.

U.S. Natural Gas Prices. The Henry Hub spot price averaged $3.56 per MMBtu in October 2011, 34 cents lower than the September 2011 average and 49 cents lower than the August 2011 average (Henry Hub Natural Gas Price Chart). This month’s Outlook lowers the 2011 forecast by 6 cents to $4.09 per MMBtu and lowers the 2012 forecast by 19 cents to $4.13 per MMBtu compared with last month’s Outlook. Natural gas futures prices for January 2012 delivery (for the 5‐day period ending November 3, 2011) averaged $3.96 per MMBtu, and the average implied volatility was 35 percent (Market Prices and Uncertainty Report). The lower and upper bounds for the 95‐percent confidence interval for January 2012 contracts are $3.06 per MMBtu and $5.13 per MMBtu. At this time last year, the January 2011 natural gas futures contract averaged $4.13 per MMBtu and implied volatility averaged 41 percent. The corresponding lower and upper limits of the 95‐percent confidence interval were $3.06 per MMBtu and $5.59 per MMBtu.

Coal

U.S. Coal Consumption. EIA expects that coal consumption for electricity generation will decline by 16 million short tons (MMst) (1.6 percent) in 2011, as the modest growth in total electricity generation is more than satisfied by increases in generation from natural gas, hydropower, and renewables other than hydropower. Projected increases in generation from natural gas, nuclear and non‐hydro renewables, combined with lower electricity consumption, contribute to an additional 4.6 percent decline in electric power sector coal consumption in 2012.

U.S. Coal Supply. EIA forecasts that coal production will fall slightly (by 0.2 percent) in 2011 despite a significant increase in coal exports (U.S. Annual Coal Production Chart). Coal production in the Western region is projected to decline, while production in the Appalachian and Interior regions increases slightly. EIA expects coal production to decline by 3.6 percent in 2012 as domestic consumption and exports fall and inventories at electric power plants decline (U.S. Electric Power Sector Coal Stocks Chart).

U.S. Coal Trade. U.S. coal exports rose to 54 MMst during the first half of 2011, the highest since 1982, representing about a 35 percent during the first half of 2011 compared with the same period in 2010. EIA expects U.S. coal exports to remain elevated over the second half of 2011, reaching an annual total of 102 MMst. Forecast U.S. coal exports fall back to 91 MMst in 2012, as supply from other major coalexporting countries recovers from disruptions.

U.S. Coal Prices. Average delivered coal prices to the electric power sector have increased steadily over the last 10 years by an average of 6.7 percent each year. EIA expects that this trend will continue in 2011, largely because of a rise in transportation costs. The projected average delivered coal price to the electric power sector, which was $2.26 per MMBtu in 2010, rises to $2.41 per MMBtu in 2011 and $2.44 per MMBtu in 2012.

Electricity

U.S. Electricity Consumption. Total U.S. consumption of electricity across all sectors is forecast to fall by 0.6 percent during 2012 after having grown by an estimated 0.3 percent this year (U.S. Total Electricity Consumption Chart). Despite the recent cold snap and snowstorm in the Northeast, NOAA expects overall temperatures this U.S. Energy Information Administration/Short-Term Energy Outlook — November 2011 8 winter to be milder than last year. In the South Atlantic region, where a majority of households heat with electricity, heating degree‐days between October 2011 and March 2012 are expected to be 5.9 percent lower than in the same period last year. This implies a drop of 2.6 percent in winter electricity sales to the residential sector in the South Atlantic.

U.S. Electricity Generation. EIA projects total U.S. generation by the electric power sector will average 10.9 terawatt hours per day during 2011. Coal is expected to fuel about 44.9 percent of this generation, down from a 46.1 percent share last year. During 2012, EIA expects coal to supply about 43.5 percent of total generation. In contrast, the share of generation fueled by natural gas is forecast to rise, growing from 22.6 percent in 2010 to 22.8 percent in 2011, and 23.7 percent in 2012 (U.S. Electric Power Sector Generation Chart).

U.S. Electricity Retail Prices. The cost of coal delivered to electric generators is expected to increase by 6.4 percent during 2011, while the delivered cost of natural gas continues to decline. The net effect will be relatively modest growth in retail electricity prices over the forecast horizon. EIA expects average U.S. residential electricity prices to increase by 1.7 percent in 2011 and by 1.2 percent in 2012 (U.S. Residential Electricity Prices Chart).

Renewables and Carbon Dioxide Emissions

U.S. Renewables. Led by a 23‐percent increase in conventional hydropower, the total supply of renewables is projected to grow by about 12 percent from 2010 to 2011. EIA expects total renewable energy supply to decline by 1.1 percent in 2012 as a 12‐percent decline in hydropower offsets growth in other renewable energy supplies. U.S. hydropower generation during 2011 is expected to reach the highest level since 1999, primarily because of high levels of precipitation in regions such as the Pacific Northwest. EIA assumes a return to normal snow and rainfall levels in 2012, with hydropower generation falling by 0.36 quadrillion Btu (12 percent). Wood and wood waste is second only to hydropower in terms of the total energy supplied by renewable sources. Because much of the wood supply is subject to industrial market conditions, especially in the pulp and paper industry, a decline of 2.4 percent is projected between 2010 and 2011 as output from the paper industry is projected to decline more than 1 percent. Wood supply growth picks up in 2012 to a projected rate of 1.8 percent.

Wind energy is estimated to have grown by 23 percent from 2010 to 2011. Growth in wind energy in 2012 is projected to slow to 15 percent as the expiration of the production tax credit nears. The solar energy supply is projected to grow by 4.5 percent and 4.9 percent in 2011 and 2012, respectively, reaching a total of 0.12 quadrillion Btu.

In terms of liquid renewable fuels, EIA estimates that biodiesel production in 2011 averaged about 56 thousand bbl/d (860 million gallons total annual production). This volume surpasses the 2011 Renewable Fuel Standard (RFS) Biomass‐Based Diesel mandate of 800 million gallons. RFS credits generated above the current mandate can be banked and used for compliance in the following year for up to 20 percent of the requirement. The $1 per gallon biodiesel tax credit expires at the end of 2011. In 2012, biodiesel production is forecast to grow slightly higher to 61 thousand bbl/d (940 million gallons), just reaching the proposed 2012 RFS mandate of 1.0 billion gallons after accounting for 60 million gallons of 2011 credits.

Ethanol production growth, which averaged 120 thousand bbl/d annually between 2005 and 2010, is expected to slow to 30 thousand bbl/d in 2011 and 20 thousand bbl/d in 2012, reaching an average of 920 thousand bbl/d in 2012. Ethanol exports reduce the volume of ethanol blended into gasoline. Assuming ethanol net exports average about 40 thousand bbl/d next year, EIA expects that 880 thousand bbl/d of ethanol will be blended into gasoline in 2012. The expiration of the Federal motor fuels excise tax credit for ethanol blending is expected to have little effect on blending levels, as ethanol producers do not currently appear to be capturing much of the value of the credit.

U.S. CO2 Emissions. EIA estimates that CO2 emissions from fossil fuels increased by 3.9 percent in 2010 (U.S. Carbon Dioxide Emissions Growth Chart). Forecast fossilfuel CO2 emissions fall by 0.6 percent in 2011, as increasing emissions from higher natural gas consumption are offset by declines in coal and petroleum consumption. Increases in hydroelectric generation and other renewable energy sources in 2011 also help to mitigate emissions growth. Fossil‐fuel CO2 emissions in 2012 are expected to decline by about 1 percent as emissions from coal decline by 4.1 percent. That decline more than offsets expected increases in emissions from petroleum (0.4 percent) and natural gas (1.3 percent).

Outlook 2011 Alternative Energy Industry on Great Recession

Alternative Energy industry was hit hard by the Great Recession and essentially remains in recovery mode. And while the economy is in recovery mode, so is our hope for the industry. The growth outlook of alternative energy companies is closely tied to the fortunes of the economy.

Despite some lingering concerns, the global economic expansion remains on track. Per the Energy Information Administration (EIA), in its latest release U.S. electricity consumption is expected to rise year-over-year by 4.7% in 2010.

Going forward, in fiscal 2011 we expect the U.S. Gross Domestic Product (GDP) to grow 3.7% year-over-year. Along with this, a faster decline in the unemployment rate will jack up electricity demand, funneling investor interest in the sector. Also, the outlook for the major emerging market economies remains positive. And while stock prices of alternative energy companies have recovered from their lows, valuations still remain quite attractive by historical standards.

A number of traditional utility companies have growing alternative energy operations. But the fortunes of some of these companies, particularly those with significant fossil-fuel exposures, are less attractive than their peers.

In the utilities space, we are less optimistic about the prospects of Allegheny Energy Inc. (NYSE: AYE – News), American Electric Power Co. Inc. (NYSE: AEP – News), DPL Inc. (NYSE: DPL – News) and DTE Energy Company (NYSE: DTE – News). Conversely, favorable rate cases and stable sales growth in the respective service areas make companies like Brookfield Infrastructure Partners L.P. (NYSE: BIP – News), ALLETE Inc. (NYSE: ALE – News), Consolidated Edison Inc. (NYSE: ED – News) and OGE Energy Corporation (NYSE: OGE – News) attractive in the near-term.

A major growth area in this space is Solar Energy. The U.S. has a lot of catching up to do, despite enormous potential, to get anywhere close to the global leaders. According to the Solar Energy Industries Association (SEIA) — the U.S. trade association of close to 500 companies in the solar energy industry — Germany ranked first followed by Spain, Japan and then the U.S. in terms of cumulative installed solar electric power capacity, as of year-end 2009.

In fiscal 2009, Germany (3.8 GW) was far ahead of the pack in terms of new installations, with Italy (700 MW) coming a distant second. However, the gap is closing fast as SEIA estimates the U.S. saw more than 1 GW of new solar installations in 2010 alone.

According to the European Photovoltaic Industry Association (EPIA) — the world industry association for solar photovoltaic electricity market — the cumulative global installed PV capacity stood at almost 22 GW at the of 2009, compared to only 9 GW at the end of 2007.

Here we take a look at the Solar Energy space and attempt to identify this nascent industry’s strengths and weaknesses.

OPPORTUNITIES

Environmental Advantage: Solar power is one of the most benign electricity resources. Solar cells generate electricity without air or water emissions, noise, vibration, habitat impact or waste generation.

Fuel Risk Advantage: Unlike fossil and nuclear fuels, solar energy has no risk of fuel price volatility or delivery risk. Although there is variability in the amount and timing of sunlight in the day, season and year, a properly sized and configured system can be designed to insure high reliability while providing a long-term, fixed-price electricity supply.

Location Advantage: Unlike other renewable resources such as hydroelectric and wind power, solar power is generally located at a customer’s site due to the universal availability of sunlight. As a result, solar power limits the expense and energy losses associated with the transmission and distribution from large-scale electric plants to the end-users. For most residential consumers seeking an environment-friendly power alternative, solar power is currently the only viable choice being a ubiquitous source.

Environmental Legislations: Alternative energy companies are increasingly benefiting from new legislation in the U.S. stipulating installation of renewable sources of electricity generation as mandated by Renewal Energy Standards (RES). At the federal level, Congress has extended the 30% federal investment tax credit (ITC) to both residential and commercial solar installations until December 31, 2016.

Also, under the American Reinvestment and Recovery Act (ARRA) passed in February 2009, the U.S. Treasury Department implemented a program to issue cash grants in lieu of investment tax credit for renewable energy projects.

Subsidy Programs: Governments, most notably China, Japan, Canada, U.K., Australia, India and the Middle East, have increased their financial support for solar projects. China is aiming at increasing its installed solar power capacity to 20 GW by 2020 from 305 MW capacity at the end of 2009. Specific solar energy stocks under our coverage that stand to benefit from this environment with a Zacks #1 Rank (short-term Strong Buy rating) include China Sunergy Co. Ltd. (NasdaqGM: CSUN – News), LDK Solar Co. Ltd. (NYSE: LDK – News) and JA Solar Holdings Co. Ltd. (NasdaqGS: JASO – News).

WEAKNESSES

Recent Start-ups: A large number of these companies are recent start-ups with limited resources. As such, quite a few depend on their customers’ ability to finance solar projects and remain exposed to continuing near-term losses due to start-up costs. Companies such as Evergreen Solar Inc. (NasdaqGM: ESLR – News) and Ascent Solar Technologies Inc. (NasdaqGM: ASTI – News) would fall in this category.

Subsidy Roll-back: Budgetary constraints have caused prime solar markets in Europe like Germany , Italy, Spain and U.K. to roll back a portion of its grants. This may affect companies such as First Solar Inc. (NasdaqGS: FSLR – News) and SunPower Corporation (NasdaqGS: SPWRA – News), which generate a substantial portion of their sales from markets like Germany.

Fortunes Tied to Crude: Alternative energy stock prices generally rise and fall in direct proportion to the price of crude oil. While in times of high oil prices this may present an opportunity, it also increases volatility in the sector. The improving economic scene, both here in the U.S. as well as worldwide, had been the main driver of the oil rally that saw the commodity zoom past the $91 per barrel level at year-end 2010.

However, in recent days, concerns about the European debt crisis and China’s growth outlook have renewed apprehensions about the global growth and energy demand. As a result, oil prices have slumped to below $90 per barrel. Also, the Paris-based International Energy Agency (IEA), the energy-monitoring body of 28 industrialized countries, is asking Organisation of the Petroleum Exporting Countries (OPEC) to raise production. This will add further tailwinds to oil prices.

New technologies are emerging: The alternative energy industry remains an emerging sector with a consistent focus on the lowest cost technology to be cost competitive with traditional means of electricity generation. This may prove disastrous for existing companies ruling the solar roost should a cheaper alternative emerge.