How Does the Financial Crisis Affect the Peak Oil Thesis? 31 comments
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Michael Shedlock has a great post on the recent slide on oil prices. Shedlock has been predicting a deflationary scenario as a consequence of the credit bust even when commodities reached all-time record highs earlier in the year. Due to oil’s rapid descent past his $70 target, Shedlock is now predicting possible $50 - $60 oil.
What’s interesting about Shedlock’s call is that he fully acknowledges the possible reality of peak oil but does not think peak oil, alone, is enough to drive prices into the stratosphere irregardless of economic fundamentals. He also asserts that peak oil has already been priced in.
In some ways, I agree with Mish. I have taken some flack for suggesting that energy investors should still demand a margin of safety, peak oil notwithstanding, and not depend solely on rising oil prices. If you look at the Seeking Alpha comments from my analysis of Penn West’s (PWE) Q1 2008 results, you’ll see some readers seemed to think that oil was going straight up despite poor company fundamentals, much less broad macro fundamentals. So I do not disregard Mish’s call that oil is headed lower from here.
Where I do disagree is Mish’s assertion that peak oil has been priced into the oil price. Perhaps there are some indications of long-term supply concerns priced into oil, especially as you go further out along the strip but I don’t believe that peak oil has been fully priced into the commodity. If it were, oil prices would have to be higher or possibly, oil would no longer be freely traded in the market (for national security reasons).
Perhaps a useful analogy would be the recent housing bubble. Many market watchers were aware of the housing bubble popping as early as 2005. By mid-2007, the public at large were fully aware of the subprime problem. So was the housing bust and its financial fallout then fully priced in the stock markets? Had the markets fully priced it in by the time Bear Stearns was taken under? When the Feds took over the GSEs? Indymac? Lehman’s bankruptcy? Even now, have the markets fully priced in the fallout from the credit crunch?
My points are twofold: first, peak oil is still not readily accepted as conventional wisdom and second, even if a condition is widely acknowledged, such as the housing bust starting in Feb 2007, it does not ensure that the market has accurately priced it. Keep in mind that US indices hit all-time highs as late as Oct 2007 despite the full knowledge of the bust.
My thoughts on investing in oil: I think both Mish and I would agree that oil prices are headed higher (relative to other asset classes) in the long term. Investors who can afford to ignore the short to medium term fluctuations are being gifted a real opportunity here. Perhaps the hard truth is that America, for its long-term benefit, needs energy prices to remain elevated; otherwise, market participants won’t have the incentive to increase productive capacity, to find new reserves or to develop viable alternatives. This will lead to even harder conditions down the line and possibly even higher prices than would be the case if energy prices were to stay in painful territory now. So if demand truly drops off the cliff and oil heads to $60 or lower, it may lay the foundations for an even more violent move up later down the road.
Keep in mind, investors may have to bear considerable volatility and pain in the meantime. By focusing on energy producers with strong cash flows, low debt levels, manageable political risk and good dividend yields, investors can minimize the turbulence while waiting out for the peak oil situation to slowly play itself out.
Disclosure: Author holds a long position in PWE
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This article has 31 comments:
Good analysis of the current oil situation. I agree that in the long term, oil will not stay at current lows. Having said that, in your view, what is the time span of the turbulence you are referring to in your article.?
I am also long in PWE and intend to stay long there and collect the dividends. However, I am not sure that PWE or other CANROY's will be able to maintain current levels of payouts per unit trust.
Injecting Peak Oil THEORY changes the focus of the discussion away from supply/demand, and leads to emotional responses that obfuscate facts.
As an aside, I think Peak Oil theory is still a theory (though an important one). I tend to think that as the price of oil goes up, the price will justify the development of new technologies for the successful exploration of new oil fields in presently difficult/impossible places...I also tend to think it may not matter, as higher prices lead to the development of alternatives. The greater the availability of alternatives, the less the impact of oil--peak or otherwise.
In 2006, interest rates were raised in the USA, so the monthly bill, usually poor borrowers of subprime mortgages had to pay, rose dramatically, until they could no longer pay it and saw their houses confiscated; thus contributing to the housing market plunge.
Finally, interest rates were increased in order to fight rising inflation, which started with the dramatic surge in oil prices the world faced over the past few years. So yes, the financial crisis finds its roots in the oil crisis and nobody seems to care about it.
The current events that nobody saw coming, were already announced in as early as 2006 by Dr. Colin Campbell, a renowned geologist:
"Expansion becomes impossible without abundant cheap energy. So I think that the debt of the world is going bad. That speaks of a financial crisis, unseen, probably equalling the Great Depression of 1930; it's probable we face the Second Great Depression. It would be a chain reaction, one bank would fail, and another one would fail, industries will close…"
www.ireport.com/docs/D...
why? PWE has been paying the same div when oil was $50...
Well, we've just seen the first wave of demand destruction as a result. Expect economic growth to resume until we again hit the new (lower) supply limit and the price spikes again. And again, demand is destroyed.
The need for cheap gasoline to encourage consumers to spend is coming about; as a hoped for market rally is needed to dispel fear.
The demand for oil is not one half of what it was; and yes speculation was a part of the highs.
I really wonder how much oil is coming out of our federal reserves as a means of driving prices down?
Two and a half more weeks of low oil is expected, however January new president prices will be higher in my opinion.
"There is such a word, however. It is still used primarily in speech, although it can be found from time to time in edited prose."
How about "flammable" and "inflammable" ????
You gotta have a real headache with those.
Also, dividends matter: If COSWF cuts its dividend from 1.25 per quarter to .75 per quarter, that still a $3.00 per year payout on a $22.00 security for a 13.6% yield. I can wait a very long time and get paid 13.6% to wait.
In short, prices are the lesser part of the equation (to a certain point--obviously if prices plunge to 50 dollars a barrel, then companies shut down production, and many of the big oil sands projects coming online need $80 to be marginal. )
Right now the downside looks very limited, and the upside looks very bright...but you might wait 3-5 years to play out.
This material driven convergence of different technologies, ( nano-solar, thermo-electrics & storage) will end the Combustion age.
Pyrolysis of Biomass & Charcoal to the soil is a bridging first step as other energy conversion technologies bloom from Nano and bio research. Thankfully we can do Terra Preta soils (TP) now.
TP starts as a soil nano technology with increased CEC, than a micro tech with soil food web wee-beasties & fungus, and macro with bugs and worms, all with off the shelf technology.
Biomass/Biofuels as one of many energy bridges to a Post-Combustion age would best be built to be a Non-Combustion process that sequesters carbon in soil.
Pyrolysis does have an energy penalty. However the concomitant benefits to soil biomass & productivity, while vastly reducing GHG soil emissions, gives us an ever growing virtuous energy cycle.
I noted in your comment that you believe "Peak Oil" is just a theory. I admit that the "Peak Oil" production position for this planet is not currently knowable (only educated guesses at best) and therefore not really germane to shorter term price (supply and demand) discussions. So I do believe the insertion of "Peak Oil" into this headline leadin is just a teaser with little regard for the actual content.
I posted this earlier on another article on oil and it addresses "Peak any non-renewable commodity.
>>"How can you persist in calling "Peak Oil" a theory. When there is a finite quantity of ANY product or resource that is being consumed grand scale, you will have a "Peak XXXXXX" There are capped oil wells in both east and west Texas that reached their peak production prior to 1962. There are entire oil fields in California that reached peak production at mid century. There are regions such as the Permian Basin in west Texas and east New Mexico and Catarell in Mexico which have been in decline for over a decade. And, indeed, there are countries that are pumping less every year. The pool is being sucked dry worldwide. While some field's production is questionable ( i.e. Saudi), others are yet being discovered. Yes, Russia is pumping more and may not peak for some time but Norway and UK have to look forward to a lot less from the North sea platforms.
The point is that you (all countries) have proof that harvesting non-renewable, non-recyclable "stuff" is in decline. There is no argument here, scientific or otherwise, to dispute this "law of use and depletion of non-renewable resources". So it is not a theory. It is provable! <<
Rikiki
This is a combination of countries charging more for extraction of natural resources as well as higher production costs from more difficult sites.
From an historical perspective concerns about running out of oil have occurred since the 1920s. In the late 1980s and 1990s oil became very cheap, so exploration and technology development for extraction of unconventional oil declined, as did new exploration. In addition, the US government took many promising geographies off the table for exploration and development. In only the past 5 years have oil prices reached levels to start large scale new production.
This is part of the economic cycle of extraction resources - commodity prices get high, new production goes on-line (can take 5-15 years to happen), excess production and demand destruction from high prices makes prices rapidly fall making for cheap prices; mines/wells become depleted while few new wells/mines (and technology) are made due to low prices, shortage of production causes prices to rise and the cycle begins again. This happens for oil, copper, iron, etc.
The key item to watch is what is the cost of new production which includes risk adjusted profit, as well as a much bigger cut of the revenue for the government in which the oil is extracted from. This helps us know the floor on oil prices.
The second item to watch is what is the cost of oil substitutes - this is to establish a ceiling on oil prices.
their own set of things to watch out for...but with a little attention an
interesting play. But you have to learn about these things...you can't
just pick them up and forget them. And be prepared to pull out in a
hurry if their Government gets greedy...
Plus you have to consider what the strong dollar is doing to their payouts. The Canadian dollar is approaching .80 so the .34 of PWE translates into approximately .27 US.
Conversely, they sell oil/gas in dollars and convert back into Loonies which means 25% more for them than their US counterparts. All in all, the dividend should be safe.