The Commodity Investor Q&A
With Matt Badiali
January 28, 2009

Q: I saw a report on Friday that said the supply of oil in storage went up 6.1 million barrels. Why didn't the price of oil fall? – M.U.

A: Last week, oil analysts made a huge blunder.

Most analysts thought we'd add around 400,000 barrels to storage last week. The oil in storage (often called "oil stocks") is all the oil in tank farms, pipelines, tankers, and railcars... all the oil that's been pulled out of the ground, but hasn't yet entered the market.

On Friday, the weekly oil stocks report showed oil in storage rose 6.1 million barrels. Oil analysts missed the mark by about 5.7 million barrels.

Lots of extra oil backed up in the pipe generally reduces the price of oil – it's simply more supply relative to demand. So last week's massive storage number should have sent crude down to new lows. But it actually climbed almost 10% from $42 to $46 per barrel that day.

Oil rose on bearish news. I think that means it's not going any lower.

That same kind of thing happened when oil hit its top...

Last September, Nigerian militants bombed an important oil pipeline and pledged to destroy oil infrastructure in the Niger River delta region. Nigeria produces about 7% of our total foreign imports, and attacks on infrastructure would cripple its ability to supply that oil.

Less than a week after this news – which should have sent oil soaring – the price of crude had fallen from $120 to below $100 per barrel.

When the price of a commodity – or a stock for that matter – heads the wrong way on bullish news (like bombing infrastructure) or bearish news (like massive supply growth), that's a turning point. This time, it's a signal oil has fallen as low as it's going to go.

Q: I saw Suncor lost money in the fourth quarter and the stock fell 12% on the day it was announced. What do you think this means for tar sand companies? – M.M.

A: Suncor's 12% drop didn't push it back to 52-week lows, but it was close. And I think it's a sign things are going to be ugly for oil-sand companies this quarter. Here's why...

Suncor needs oil to sell for $49 a barrel to break even. I think we'll get there soon, but in the meantime, the company is losing money on every barrel it pumps. When the biggest, best company in the place is getting its ass handed to it every day, less well-established companies are going feel even worse pain.

Take BA Energy for example. BA was building a $4 billion tar-sand "upgrader," sort of a pre-refiner. BA just declared bankruptcy. And it's not going to be the only one.

I'm a huge long-term fan of the oil sands: Canada is a close, peaceful, stable neighbor... and with Mexico's wells running dry, it's our best bet for new supply. But in the short term, things are going to get worse before they get better.

Q&A update: Back in November, a reader asked why royalty trust prices were sinking, even though some were paying out dividends as high as 20%. Here's what I wrote...

Since June, Canadian Oil Sands, Penn West Energy, and Enerplus Resources – three of the biggest royalty trusts – have fallen an average 54%. Now the three yield an eye-popping 19.5%.

I don't think that's a bargain, I think it's a warning...

Earnings are headed down. And since dividends ebb and flow with earnings, dividends are about to tank, too.

Commodity Q&A: Something Terrible Is Headed for Royalty Trust Shareholders Read This Before You Buy Gold

Since then, both Penn West and Enerplus cut distributions by at least 30%. We're still waiting for Canadian Oil Sands Trust (which is essentially a dividend on tar-sand production). If Suncor's fourth-quarter loss is any indication, it'll be taking a chainsaw to distributions, too.

Here's the thing: Even after the cut, Penn West's yield is still up around 22%. And the company hedged 30% of its oil production at $80 per barrel, which will provide some support for the company's current dividend.

Once the oil price climbs past $48 per barrel (Penn West's breakeven price), this company will be profitable again. Given where I think crude is headed, I'm much closer to buying shares today than I was in November.

Good investing,

Matt

P.S. Keep your questions coming. Click here to e-mail me and check for an answer next week.