Cheap Crude: A Flash in the (Oil) Pan

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 |  Includes: BP, COP, CVX, HMC, IXC, IYE, TM, XLE, XOM
by: Michael Fitzsimmons

The biggest mistake the United States could make right now is to assume recent weakness in oil and gasoline prices means the energy crisis is over and the US can go back to our old energy habits and policies. 

An editorial in Friday's edition of The Wall Street Journal inferred that high oil prices were solely the result of weak US dollar policies which caused a speculatory oil price bubble. The author conveniently neglected to point out that while the dollar did drop roughly 40% since President Bush got elected, oil prices went up 500%. The author then recommended US auto companies not use their taxpayer bailout dollars to manufacture fuel-efficient automobiles because there would be no market for them with oil under $50/barrel, which is coming (according to him). Notably, the author neglects to mention the role high oil prices played in the current automotive manufacturing crisis as the US big three focused on gas-guzzling Hummers and SUVs as opposed to fuel-efficient intelligent design. 

Another article in The Wall Street Journal this week tried to persuade people not to buy fuel efficient cars because the money they save on gasoline won't be enough to make up for the increased insurance premiums smaller vehicles require due to safety considerations. In this article, no mention was made of the environmental costs nor of the fact it just may be better for US insurance companies to receive US dollars rather than to send them overseas to Saudi Arabia, Iran and Russia.

What short memories these folks have. It was only a few months ago that oil was close to $150/barrel. Let's look at the facts. Oil is now in the $60s not because of some huge new supply coming on line. It is low because demand has fallen off a cliff due to extreme worldwide economic weakness.

This is not the 1980s when oil went to $12/barrel due to huge supply coming online. In fact, despite the high oil prices seen in the last few years, and despite the billions spent on exploration and production, worldwide oil supply barely topped 86 million barrels per day. Oil production from Mexico, Russia, Alaska and the North Sea continues to decline due to increasing depletion rates in the mature oil reservoirs. In the last 4 quarters, oil production at US majors Exxon (NYSE:XOM), Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP) was flat or down.

Other than a handful of large oil discoveries (mostly in Brazil), elephant fields are getting harder and harder to find. When they are found, they are usually in deep offshore waters which are expensive to bring on-line. The era of abundant cheap oil is over. We are entering an era in which worldwide oil supply will not keep pace with worldwide oil demand. It's that simple.

Should we drill, drill, drill? Of course we should. Despite three massive hurricanes in the Gulf of Mexico, there was not one major oil spill or energy related environmental catastrophe. This proves the oil industry has passed the "safety" test and can surely drill safely in the waters offshore California for instance, where the weather isn't even as severe as in the Gulf of Mexico. We should also be drilling in Alaska and any other US territory which holds oil reserves (barring wilderness areas, federal and state parks, and similar areas).

The environmental impact of burning the oil is, of course, undesirable. Such is the price we'll pay for the lack of an energy policy in Washington these many years. Economically as well as structurally, the country is simply not in a position to ignore its oil reserves. Unfortunately, the current economic crisis will delay many oil producing projects the world over. This will merely exacerbate the situation when the next demand driven oil spike occurs, and it will.

Long term, any country that imports 70% of its oil, consumes 25% of worldwide oil supply, and has only 3% of the world's oil reserves must make some serious changes with respect to its energy policy. I'm talking about the United States. The US simply cannot drill its way out of the oil problem. The only solution is a strategic, long-term, comprehensive energy policy as I've outlined here.

There is only one natural gas automobile for sale in the United States: the Honda (NYSE:HMC) Civic GX. However, it's not available in many states (including mine), is more expensive than the gasoline powered Civic, and the home refueling appliance is sole-sourced, overpriced, and similarly not available nationwide. Natural gas refueling stations for the public are all but non-existent in the US. Meanwhile, oil exporting countries such as Brazil and Iran are hard at work building out their natural gas infrastructure for transportation. The US is simply asleep at the switch. Again.

The war in Iraq has cost the US dearly. Not only did it take millions of barrels of Iraqi oil off the market at exactly the same time China was pumping up demand (and therefore leading to demand as well as geopolitical risk valuation for oil), the war also drained away taxpayer money that should have been going toward alternative energy solutions. I read an article the other day that pointed out that for the price of the Iraqi war, the US could have had a world class healthcare system, a fully funded alternative energy strategy and 10 million Toyota (NYSE:TM) Priuses in American garages.

It's time for a new president. It's time for a new government. And it is time for new economic and energy policies.

Meanwhile, what is an investor to do in these times? Well, obviously my earlier advice to buy energy has led to much pain (me included!). I did mention in a few of my articles that the only way oil prices would decline appreciably would be if there was an extreme worldwide recession or depression. Well, here we are. Capitalism, as we know it, is on its way out as the US government takes over the financial system. (How ironic considering Bush is a so-called self-described 'conservative Republican'.)

Regardless, one must invest assuming the financial system doesn't completely implode, for if it does, what does it matter anyway? We are obviously in a deflationary de-leveraging cycle where cash is king and return of principal is more important than return on principal.

That said, you have a once in a lifetime opportunity to buy oil stocks at deep, deep discount prices. When stocks like ConocoPhillips and BP (NYSE:BP) are valued such that their PE is damn near equal their dividend yield, it is time to buy.

Could oil prices remain low for a year, even two years? Yes, they could. However, at some point in the future (barring a one world government or "new world order"... which is not out of the question), oil supply/demand fundamentals will again take over and we'll have another huge spike in oil prices. ConocoPhillips, Chevron, BP and Exxon Mobil will once again be right there to make huge profits. Meanwhile, an investor can collect the dividend and watch as these companies increase their downstream margins in gasoline refining.

Disclosure: the author owns all of the oil companies mentioned in this article.