The Commodity Investor Q&A
With Matt Badiali
June 11, 2008
Q: Is it too late to get into oil? Given its current run, do you see a correction coming? – M.B.
A: "Recoil" screams The Economist. BusinessWeek shows a gas gauge near empty with the headline "Oil & The Economy." Even the latest National Geographic has an oil story listed on the cover... although Stonehenge made the lead.
All this press would lead a lot of analysts to expect a top in oil... but I'm not so sure.
I've written a lot about the lack of new large oil finds and rising demand from the developing world, but here are three more factors you rarely hear about that are driving prices higher:
Decades of neglected fields: Take a look at Mexico. The country siphoned profits from its enormous Cantarell field (the second-largest field in the world) to finance government programs. Little of that money went to modernizing Pemex, its national oil company.
As Cantarell runs dry, Mexico is struggling to make up for those years of decline. That's not going to happen quickly. Venezuela and Nigeria also have large deposits that aren't being managed properly. All of this restricts supply.
Soaring demand fueled by price supports: Indonesia, for example, is a longstanding member of OPEC but will withdraw from the cartel at the end of the year. The country's production declined and its demand grew, so now it has to import oil. Indonesia long held the record for the cheapest oil and gasoline in Asia, thanks to government subsidies. That fueled high demand, which could cripple the country as it switches from net oil producer to net consumer.
A lack of alternatives: Despite claims to the contrary, you can't plug in a wind farm and expect oil prices to fall. About 76% of every barrel of oil becomes transportation fuel. About half of every barrel becomes gasoline. You can't substitute solar, wind, or hydro power for gasoline on a big scale... not yet, anyway. So keep driving and guzzling gasoline.
So even if the price of oil is peaking, it won't fall far. I think you've seen the last of double-digit oil, but it's not too late to invest. Here are three ideas you can use to profit now, even if oil prices come down off their highs:
First, I like companies that specialize in getting more oil out of oil fields. Generally, when an oil field is "depleted," 70% of the original oil is still sitting there. You read that correctly.
I like smaller companies that specialize in buying these used-up fields and rejuvenating them. These companies can buy the old fields for pennies on the dollar and don't need to spend money exploring. They know the fields are there. That's the sort of business that can hold up against falling oil prices.
Second, I like companies using state-of-the-art technology to do things no one else can.
Longtime S&A Oil Report holding Transocean recently set the world record for the longest well drilled (about 7.6 miles). These companies with specialized skills will remain busy even if oil prices sag. That's because oil companies can't afford to look at short-term price movements. They need to invest for the next five to 10 years. If a company's exploration strategy involves offshore drilling (and it probably does), then it has to hire Transocean.
Finally, I like companies that are working on long-lived assets. For example, many conventional oil fields produce for 25 to 35 years and then they die. However, some tar-sand and heavy-oil fields have 50 years or more of recoverable oil.
Suncor (the giant oil-sand mining company) put its Millennium mine into production in 1967. It still produces more than 300,000 barrels per day. A lot of Canadian oil-sand producers have these kinds of assets. I'll probably be a bull on Canadian oil sands for the next 50 years.
I'm convinced you can find some excellent investments right now in those three areas of the oil industry. If you buy the right companies, you'll have no problem weathering a fall in oil prices.
Good investing,
Matt Badiali
