With oil dropping briefly under $60 per barrel and natural gas under $5, there’s been a good deal of volatility in the energy patch. As I’ve stated in The Energy Strategist, I suspect we could see more downside or at least more sideways action until after the so-called shoulder season.

The shoulder season refers to the period between the summer cooling season and the winter heating season. Normally, the winter heating season begins in the Northeast sometime after November 1—roughly one month away. In this shoulder season, demand for energy-related commodities is weak; it’s also not a seasonally strong period for energy-related stocks.

This year, the normal seasonal weakness has been compounded by fears of a slowdown in the US and global economy. (I’ve highlighted this weakness in TES on several occasions, so I won’t rehash those arguments here.) Fears of a slowdown have kept a lid on energy prices during the past five months or so. These are the main reasons I’ve remained defensive overall on the energy patch throughout this past summer.

I suspect we’re getting close to an important low for the energy stocks if, in fact, we haven’t already put in that low. With respect to the oil market, the recent dip under $60 put crude at the low end of its valuation range.

The dip was catalyzed by a temporary easing in geopolitical tensions with respect to Iran, a slowing economy and the unwinding of some speculative positions in the oil futures market. The pain of that sharp correction was necessary to eliminate some of the froth in the oil market that built up earlier this year. Unlike natural gas- and energy-related stocks, oil showed little weakness during the past six months until the recent sharp pullback.

Falling gasoline prices in the US may help stimulate more demand for oil. Moreover, while the US economy is slowing down and the risk of a recession is rising for next year, oil’s recent pullback prices in that news. It’s quite possible that with interest rates now falling, the Federal Reserve on hold and gasoline prices moderating, the US economy could actually surprise to the upside next year. This would also have a positive effect on oil demand.

More important, as my colleague Yiannis Mostrous pointed out in the September 29 issue of The Energy Letter (www.energyletter.com), Asian growth continues to look solid. This is another key support for the oil market.

With respect to natural gas, I actually see the recent dip in natural gas spot prices and futures strip prices to be a longer-term positive. The key concern in the gas market is that inventories of gas are too high, yet producers are showing little sign of curbing their drilling activity. I suspect that this recent dip in pricing will ultimately result in a slowing in drilling activity later this fall.

With gas well decline rates at 30 percent, any slowdown in drilling will immediately result in production declines. The current oversupply of gas will be corrected as we head into the teeth of the winter heating season. Bottom line: Gas under $5 reflects short-term supply issues, not the long-term supply/demand imbalance.

In fact, stocks like gas-focused explorer EOG Resources (NYSE: EOG) are already illustrating this point. While natural gas has been falling, EOG has actually been trading in a tight range. One of the cardinal rules of trading is that stocks’ failure to react to what’s considered “bad news” is a sign that those stocks are already pricing in the negative news. This is the case with EOG.

Another key catalyst for a rally will be the upcoming earnings season. During the past three months, the energy market has focused primarily on macroeconomic and geopolitical issues. But this could all change as earnings start to roll in.

I’ll be watching the services companies. During the second quarter earnings season, none of these firms reported any real slowdown in demand. In light of further falls in both natural gas and oil, it will be interesting to see if that’s had any effect on the situation.

Most likely, the companies with international exposure have been once again underestimated; demand for services with oil above $55 is likely to be very strong. And international projects are unlikely to be delayed or canceled, with oil $10 to $20 below current levels.

But the macroeconomic picture is only half the story. Here’s a review of some stocks recommended in the TES Portfolios and my most recent advice:

Transports: Union Pacific (NYSE: UNP) and American Commercial Lines (NSDQ: ACLI)

I’ve long followed the transport stocks in TES. I first recommended them back in the fall of 2005, and we rode several to gains of as high as 100 percent by the spring of 2006. I revisited the industry in the July 12 issue, Beyond Oil And Gas. My two recommendations in the sector are railroad operator Union Pacific and barge operator American Commercial Lines.

When I recommended these stocks in July, they were both selling off mainly because the transportation stocks as a whole were pulling back; the Dow Jones Transportation Average fell roughly 20 percent between late June and early August. Union Pacific is now basically flat with where I recommended the stock, and American Commercial is up around 8 to 10 percent.

I recommend that all subscribers looking for my detailed take on this sector review the July 12 issue; my basic thesis is unchanged. The transport stocks sold off because of growing fears of a US economic slowdown.

Traditionally, transportation stocks have been an economy-sensitive group, and their fortunes have tended to rise and fall with the US economy. But this traditional rule of thumb doesn’t make as much sense because both Union Pacific and American Commercial receive most of their revenues transporting items like grain and coal that aren’t particularly sensitive to economic growth. Demand for shipping these commodities is unlikely to drop much unless there’s a major recession in the US.

That realization, coupled with growing sentiment that the US slowdown will not turn into a collapse, has reignited momentum in the transport stocks. Even with the recent uptick, it’s not too late to jump into the transport story. I’m reiterating my buy recommendation on both Union Pacific and American Commercial.

Shorts: BJ Services (NYSE: BJS), Patterson UTI (NSDQ: PTEN) and Diamond Offshore (NYSE: DO)

I covered my rationale for shorting all three stocks in the Sept. 6, 2006 issue of TES, Themes In Review. BJ Services and Patterson UTI are both heavily reliant on the North American natural gas drilling market. Although this has been a strong market for some time, I suspect growth in drilling activity will moderate soon because of falling natural gas prices. At the very least, any moderation in drilling activity will mean that BJ Services and Patterson UTI won’t be able to raise their prices as quickly as they have during the past few years; profit growth will suffer.

Diamond Offshore is a deepwater driller that isn’t overly exposed to the US market. The deepwater drillers stalled earlier this year because of the uncertain impact of a raft of new rigs due for construction in 2008-10. Some analysts believe this new supply of rigs will negatively impact the rates that Diamond can charge post-2010.

Based on current prices, my recommended short in Patterson is up 16 percent and the short in BJ Services is up 15 percent. I will likely recommend booking gains on both stocks during the next month. Stay tuned.

The short in Diamond Offshore is now showing a gain of 11 to 12 percent depending on your exact entry point. But recent contract signings for the deepwater drillers suggest that there’s more than enough demand post-2010 to soak up any additional rig supply. Therefore, I’m recommending that you cover your shorts in Diamond and book the gain.

Drillers: Rowan Companies (NYSE: RDC) and Todco (NYSE: THE)

Both of these recommended drillers are focused on the Gulf of Mexico shallow-water market. The story here is simple: Rigs are leaving the Gulf to take on highly lucrative contracts in markets such as Saudi Arabia. This will continue until Gulf day-rates increase enough to match what’s available overseas.

Right now, there’s a drastic shortage of rigs in the Gulf, supporting day-rates in the area. For a full rundown of the story, check out the September 6 issue.

Rowan recently skimmed my recommended stop loss, resulting in a loss of about 10 percent. With the story unchanged, I’m recommending all subscribers re-enter Rowan Companies at current prices, placing a stop loss order at 26.75.

Todco is an even more direct play on the shortage of rigs in the Gulf. I see firm valuation (and technical) support for Todco in the low 30s. I reiterate my buy recommendation on Todco, with a stop at 31.75.

Tankers: General Maritime (NYSE: GMR), OMI Corp (NYSE: OMM) and Frontline (NYSE: FRO)

Tanker rates have moderated somewhat since the beginning of September. But rates are roughly in line with where they’ve been in each of the past three years at this time. I suspect we’ll begin to see the normal fourth quarter spike in rates develop at some point between now and mid-October.

Tanker stocks have pulled back slightly after running up in a big way last summer. General Maritime’s comment at a recent industry conference that tanker rates might remain moderate near term because of a fall in US import demand did little to help the sector. In addition, a good bit of the weakness is likely due to simple profit taking after a big move higher.

Another concern for the group is that the Organization of the Petroleum Exporting Countries (OPEC) will reduce output more drastically; most analysts agree they’ve already cut back output slightly of late. The idea is that OPEC will want to defend oil prices around $60 per barrel and will be concerned about the speed of the recent fall in prices.

While an OPEC oil supply cut is bullish for oil prices, it’s bearish for tanker rates. Ninety percent of all oil moved from the Middle East travels by tankers, so lower OPEC supply spells less demand for tanker shipping services.

My recommendation on General Maritime remains unchanged. I’ve long recommended a pair-trade strategy for this stock. Buy General Maritime and short OMI Corp in equal dollar amounts.

This is a simple trade that takes advantage of the fact that General Maritime’s dividend is far higher than OMI’s yield. The money received in dividends from General Maritime far outweighs the dividends paid on the short in OMI.

This recommendation hasn’t been among the most successful in TES since I recommended it in 2005. In fact, it’s been one of the only losers in the Proven Reserves Portfolio. That said, I see this pair trade as a long-term play on the tankers. As I’ve said in the past, it’s only one position among several in the Portfolios; don’t assume that the tankers are a riskless group just because dividend yields are high.

With the supply of tankers set to remain flat during the next few years, I’m looking for tanker rates to remain well supported. Additional spikes in rates are likely if, as I suspect, a meaningful slowdown in China doesn’t occur until late 2007 or early 2008. General Maritime will pass through those higher rates to shareholders in the form of dividends. I’m willing to wait this one out; my recommendation is unchanged.

Although OMI’s business is solid, I’m not a fan of management’s low-dividend strategy. The short in OMI will protect us if there’s a major selloff in the tanker space as a whole.

In the September 6 issue, I also recommended a more aggressive trade in Frontline for the Gushers Portfolio. This stock narrowly touched our stop for a loss of about 12 percent once you factor in the $1.50 dividend Frontline paid in September.

I’m not convinced the selloff in Frontline was anything more meaningful than profit taking after a nice run. In addition, potential negatives like an OPEC supply cut are well known in the market and already priced in. I recommend re-entering Frontline under $41 with a stop at $33.25. Please consider using a smaller position size to guard against this stock’s inherent volatility.

Uranium Stocks: Uranium Field Bet and Cameco (NYSE: CCJ)

Cameco is the blue chip play on uranium; the company is the world’s largest pure-play miner of uranium. Although we’re still showing more than double on this stock since my original recommendation, the stock was down slightly earlier this month. The reason for the fall: A rumor that Cameco’s production isn’t enough to cover its agreed supply contracts. This assertion seemed to stem from the fact that Cameco had made a few trades in the spot market–basically the market for the immediate delivery of uranium.

I’ve heard secondhand–though I can’t confirm–that a publication made the ridiculous assertion Cameco will go bankrupt because it will lose money trying to buy enough uranium to meet its agreed supply contracts. The idea was that because Cameco is experiencing delays in some of its big mining projects, it will have to buy uranium in the spot market at sky-high prices.

I must point out that Cameco’s troubles and delays starting production from certain mines is a well-known fact. As I analyzed at length in the July 26 issue of TES, this is simply a fact of the mining industry. Delays are common, especially for underground in-situ projects.

Cameco factors in these obvious operational issues like any other mining concern when cutting contracts for supplying uranium. Management has since come out and reaffirmed its existing supplies and production estimates; there’s no evidence of any truth in these rumors.

Further, the idea that Cameco’s trades are a sign of some trouble is patently ridiculous. As I’ve stated in the past, Cameco frequently buys and sells uranium on the sport market. The company stated that its most recent spot-market purchase–the buy that seemed to spark the speculation–was an opportunistic trade that’s already been largely sold out for a gain. After all, if anyone can trade in the uranium spot market profitably, it would be the world’s largest miner.

The company’s stock has recovered most of that one-day loss. I still see Cameco as an attractive buy at current levels.

My second play on uranium is what I call my uranium field bet. Uranium mining is a risky business. Production delays, unforeseen project cost and simple labor, and raw materials inflation can all have important effects on the economics of a particular mining project. And production costs vary wildly depending on the grade of ore mined and how large overall reserves are.

Riskier still is exploration. Uranium explorers buy acreage and drill holes, taking core samples to evaluate reserve size and ore grades. Sometimes even the most-promising reserves don’t pan out and can never reach economic production. It’s impossible to know this for sure until you’ve spent considerable sums on exploration; only once uranium is produced can we really know for sure the full costs and viability of a project.

To account for this higher level of risk, I’m recommending that risk-tolerant investors take a more diversified approach to playing the junior uranium producers and exploration companies. One must recognize that no matter how careful your selection criteria, some promising uranium exploration stories will never work out.

For the best chance at big returns, I recommend casting a wide net. Instead of just buying one or two high-risk names, I recommend placing a smaller amount in five to 10 such companies. I call this the uranium field bet.

The recent action in several recommendations within the field bet illustrates the validity of this approach. Specifically, Uranium Resources (OTC: URRE) tumbled after reporting production problems. Though the stock has since recovered a big chunk of its one-day losses, it’s still down from my recommendation by a significant amount.

I see Uranium Resources production problems as a classic example of the mining risks I highlighted in the July 26 issue. The company’s mines are mainly underground in-situ mines, and a shortage of rigs, personnel and permitting delays means that Uranium Resources won’t meet its 2006 production goal of 670,000 pounds of uranium. Management also pulled guidance for the next few years until it can better quantify the impact of recent delays.

This isn’t a positive development by any wild stretch of the imagination. Uranium Resources is one of only a handful of companies globally with proven production. The fact that its mines are in the US is another advantage.

The subsequent bounce in the stock suggests the initial selloff was a panicky overreaction. Uranium Resources is speculative, but I’m recommending you stick with it as part of the widely diversified field bet.

And, it’s worth noting that the loss on Uranium Resources is offset by gains in several other uranium field bet picks, including Paladin Resources (TSX: PDN), UEX Corp (TSX: UEX) and Uranium Participation Corp (TSX: U).

I’d also point out that uranium prices continue to rise unchecked, now topping $54–up from the mid-$30s at the beginning of 2006.

Sasol (NYSE: SSL)

My recommended stop loss in Sasol was recently touched for a loss. Sasol is the world’s premier play on gas-to-liquids (GTL) and coal-to-liquids (CTL) technologies. (For a detailed rundown of these technologies, please check out the April 12 issue of TES, Finding New Btus.)

Sasol has suffered from a few key negatives. First, the company is based in South Africa, and there’s talk of a windfall profits tax in that country. This is a negative.

Moreover, most stocks with any connection to coal have seen selling in recent months. Sasol tends to get lumped in with that group.

Finally, Sasol has been experiencing some delays with major projects including the giant Qatar GTL project. The most recent delay was due to the failure of some equipment. Also problematic, costs for these projects have been rising because of shortages of skilled labor, equipment and engineering services.

I’m a long-term believer in GTL and CTL. CTL allows America to leverage giant coal resources to help lessen dependence on foreign oil. Sasol is a volatile stock, but I don’t see much downside from current prices. I recommend re-entering Sasol at current levels and setting a new stop at 26.50.

Master Limited Partnerships (MLPs)

My recommended MLPs have continued to perform very well despite weak oil and gas prices. This is particularly true of high-growth MLPs such as Williams LP (NYSE: WPZ) and Sunoco Logistics (NYSE: SXL). I continue to see the MLPs as a defensive income play that’s very attractive in the current environment. I recommend that all subscribers review the August 9 issue of TES, Playing Defense.

The only weak MLPs among my recommendations have been the coal-focused names: Penn Virginia Resource Partners (NYSE: PVR) and Natural Resource Partners (NYSE: NRP). Neither is close to activating my recommended stop losses; when you factor in dividends, both stocks are holding their own.

The most recent weakness is mainly because of falling coal prices, coupled with a brokerage downgrade a few weeks ago. I continue to see these MLPs as a defensive way to play coal.

In addition, I’m looking for coal prices to bottom out this fall alongside natural gas. Coal and gas are seen as substitutes for electricity generation; this will help the coal MLPs.