We'll Never See $50 Oil Again

We'll Never See $50 Oil Again
By Matt Badiali
November 11, 2009

Analysts judge oil companies on two key statistics – reserve replacement costs and recycle ratio.

In other words, how much it costs a company to replace each barrel of oil it produces and how efficiently the company does it. Analysts treat lavish exploration budgets as a black mark.

So as I explained last week, many oil companies have learned to perform a little reserve shell game... You see, while oil exploration is expensive, natural gas exploration isn't. Buying up gas shale properties can add gaudy reserves at a relatively low risk and cost.

That's why many public oil and gas companies added huge leases in the major shale plays over the last few years. That gas pads the companies' ratios, and that's as far as many analysts go.

But this masks a critical fact: Oil reserves are falling among the giant oil companies.

The three U.S. majors – Chevron, ExxonMobil, and ConocoPhillips – hold 72% of the oil reserves among the public U.S. oil companies. The oil reserves of those three fell 6% from 2005 to 2008. That 1.4 billion decline in reserves is two-thirds as much oil as the next largest oil company's entire oil reserves.

A quick check of the oil industry shows only 30 companies with more than 45% oil reserves. Even venerable ExxonMobil, the best-run oil company in the world, hasn't replaced its oil reserves. In 2003, the company had 12 billion barrels of oil... Today, that's down to 10 billion barrels. That means it's replacing about 75% of its annual production. This is unsustainable in the long run.

We simply aren't replacing our oil reserves, and that is important because it means oil... any oil... will be more valuable tomorrow than it is today.

I don't like to make predictions about commodity prices. Usually, gut feelings are no better than a coin flip. But I can't see how we'll ever pay less than $60 a barrel for oil again. Even if oil dips below that level... it won't stay there.

Finding oil is much harder today than it used to be. And it's a lot more expensive to extract.

Consider Brazil's Petrobras. The company has found more than 10 billion barrels of oil at its Tupi field, off the coast of Brazil. However, that oil is buried beneath 1.3 miles of water and 3.5 miles of thick salt and sediments. It costs $240 million to drill a single well at Tupi. Tapping the field will run in the tens of billions of dollars.

The story is the same all over the world. Lots of oil, but none of it cheap to extract.

That's great news for Canada. The stuff in Canada's oil sands is one step above roofing tar. It is difficult to get it out of the ground, and it takes extra effort to refine. When we're rolling in easy oil and the price drops below $45 per barrel, this is a marginal business.

Commodity Q&A: This Commodity Is a WAY Better Buy Than Natural Gas

A Realistic Shot at Making 200% in the Canadian Oil Sands

But if oil holds above $60, as I expect it too, then the Canadian oil sands are a great investment. The big names here Suncor (SU) and Canadian Oil Sands Trust (COS on the Toronto Stock Exchange).

Now, oil has more than doubled since the start of the year. I don't expect it to fall back to its lowest levels, but it could still get hit with a healthy correction. If you're buying into the oil sands now, be prepared for a few bumps in the bull market.

Good investing,

Matt

P.S. I just devoted the most recent issue of the S&A Resource Report to my favorite oil sands company on the market today. It's a tiny player managed and owned by some of the greatest resource investors ever. Smart buyers should make hundreds of percent on the stock as the price of oil climbs in the coming years. You can learn more about a trial subscription to the S&A Resource Report here.

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•	Google breaks out to new 52-week high... up 42% in the last six months.
•	Major U.S. health care fund reaches new high... holdings include WellPoint, Aetna, and UnitedHealth.
•	Precious metals rally drives platinum fund and silver royalty specialist Silver Wheaton to new 52-week highs.
•	Soft drink giants Coca-Cola and PepsiCo hit fresh highs.

	Last	Change	52-Wk
S&P 500	1097.91	+0.94%	+16.73%
Oil (USO)	40.76	+0.77%	-31.35%
Gold (GLD)	104.23	+1.02%	+35.00%
Silver (SLV)	14.44	+1.51%	+88.95%
U.S. Dollar	75.28	-0.01%	-9.39%
Euro	1.50	+0.11%	+12.20%
VIX	21.49	+0.28%	-69.44%
HUI	448.69	+0.60%	+120.38%
10-Year Yield	3.40%	-0.02	-0.47

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Company	Sym	Industry
PepsiCo	PEP	soft drinks
Colgate-Palmolive	CL	personal products
Canadian Natl Rail	CNI	railroads
ADP	ADP	payroll
Starbucks	SBUX	coffee
Centurytel	CTL	telecom
Petrobras	PBR	Big Oil
United Tech	UTX	conglomerate
Altria Group	MO	cigarettes
Illinois Tool Works	ITW	machinery
Kellogg	K	packaged foods
Telmex Intl	TII	telecom
Crown Castle	CCI	telecom
Google	GOOG	online search
American Express	AXP	credit cards
Texas Instruments	TXN	semiconductors
Danaher	DHR	conglomerates
Viacom	VIA	TV programming
Con Ed	ED	utilities
Estee Lauder	EL	make-up
HSBC	HBC	bank
Amazon	AMZN	online shopping
SPDR Gold	GLD	gold fund
Express Scripts	ESRX	pharmacy mgmt
Adobe	ADBE	software
HJ Heinz	HNZ	packaged foods
NetApp	NTAP	data storage
Telefonica	TEF	telecom
Bristol-Myers	BMY	Big Pharma
Travelers	TRV	insurance
Covidien	COV	medical devices
Allergan	AGN	pharma
Paychex	PAYX	payroll
Dish Network	DISH	satellite TV
Coca-Cola	KO	soft drinks
Medtronic	MDT	medical devices
MedcoHealth	MHS	pharma
Dominion Res	D	utilities
Best Buy	BBY	gadget stores
Quest Diagnostics	DGX	medical research
Novartis	NVS	Big Pharma
Diageo	DEO	liquor
Kimberly-Clark	KMB	hospital supplies
General Mills	GIS	packaged foods
McKesson	MCK	medical supplies
Eaton	ETN	electrical equip

Company	Sym	Industry
Luminex	LMNX	medical supplies
Idenix Pharma	IDIX	biotech
Western Refining	WNR	refining
Smithtown	SMTB	bank
Rosetta Stone	RST	language software
Progenics	PGNX	biotech
First Commonwealth	FCF	bank
First Merchants	FRME	bank
WesBanco	WSBC	bank
MiddleBrook	MBRK	pharma
Western Alliance	WAL	acquisitions
Vitacost	VITC	mail order

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