From the February 01, 2011 issue of Futures Magazine • Subscribe!

Will energy markets stay supported by bailouts in 2011?

Looking at the energy sector, 2010 was largely the year of the bailout. While supplies remained plentiful and demand never fully recovered, the fiscal policy of several central banks supported energy prices, except for natural gas. Crude, heating oil and gasoline futures all hit yearly highs as we turned the calendar.

"If you look at the big picture going into 2011, the question is, ‘Is oil ready to stand on its own two feet?’" says Phil Flynn, senior energy analyst at PFGBest. "As impressive as the end of 2010 was as we pushed back toward 2-1/2 year highs, let’s face it, oil got a lot of help. Looking over 2010, it was the year of oil price bailouts where oil prices got bailed out time and again."

Between the Dubai credit crisis in late 2009, the European sovereign debt crisis in the spring, and the announcement and subsequent initiation of the second round of quantitative easing (QE2), nearly every time oil prices were falling some government bailout plan provided a boost (see "Down, but not out").

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A lot of these issues are still with us in 2011 as the U.S. economy is still struggling, the Federal Reserve wrestles with an exit strategy and European debt problems are far from being resolved. Further, China continues to face soaring inflation at a rate that may affect the global economic recovery should the new asset bubbles collapse.

While the United States is still struggling with high unemployment numbers and other vestiges of the recession, some positive signs are beginning to take shape.

"Nearly all of the macroeconomic data that has come out the last couple months has been very suggestive of the global economic recovery continuing," says Dominick Chirichella, founder of the Energy Management Institute. "We’ve seen energy demand growing and for the first time in several years we’re seeing inventories pointing toward a more normal level."

While still higher than pre-recession numbers, weekly ending stocks of crude oil are beginning to decline as demand is picking up. This is particularly evident in the performance of U.S. equities, which largely have moved in correlation with crude prices (see "I move, you move").

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"The perception trade has been to watch currencies and the equities markets because equity markets are very correlated to GDP and GDP is correlated to energy consumption. That’s been the driver, but now we’re seeing perception and reality moving a little closer," Chirichella says.

Even though crude oil stocks are higher now than they were a year ago, the U.S. Energy Information Administration (EIA) is projecting stocks to fall throughout most of the year to more normal ranges (see "Return to normal").

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With the U.S. economy gaining strength at the end of 2010, many analysts wondered how the Federal Reserve would react, considering it had just initiated its $600 billion QE2 in November. During a "60 Minutes" interview in December, Fed Chairman Ben Bernanke said a third round of quantitative easing was "certainly possible."

"The most positive potential benefit for oil from QE2 was a weaker dollar. When Bernanke [telegraphed] QE2 in August, that was when we got the biggest bang for the buck on the push down on the dollar," Chirichella says.

Yet, the beginning of 2011 saw a rising dollar and improving equities leaving some to wonder if it were already time to remove the stimulus. The minutes to the Federal Open Market Committee’s (FOMC) December meeting showed that the Committee felt economic growth was slowing based on housing figures and did not make changes to QE2.

"QE2 did help stimulate the economy and increase oil demand expectations," Flynn says. "If QE2 is going to work, then it has to come to an end. If it comes to an end or the markets anticipate a stronger economy, then we should really see a stronger dollar and a stronger dollar should offset some of the upward pressure we’ve seen [on crude oil]."

Europe continues to be a concern for the energy sector in 2011. In 2010, we saw debt concerns and bailouts for multiple European countries. "Europe has really weathered the storm with the financial crises they’ve had, but there are still some countries with debt considerations," says Rob Kurzatkowski, senior commodity analyst at optionsXpress.

Largely, a split Europe is taking shape in which core countries, such as Germany, continue to grow and show robust manufacturing data while periphery nations continue to grapple with debt and recovery.

"If we look at the overall consumption for oil in 2011, most forecasters are looking at a 500,000-barrel-a-day lower growth rate than we saw in 2010. In 2010, on a global basis oil consumption grew by about 2 million barrels a day," Chirichella says. "Much of the difference is from Europe being in a slow and grow mode and the developing world being in inflation fighting mode."

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