Oil: Despite Decline, A 'Must-Have' Profit Play

Commodities may be down, but they’re not out – and they shouldn’t be out of your portfolio, either.

As the investment director for Money Morning, I’m invited to a large number of speaking engagements each year. It’s something I enjoy, and it’s quite useful, too, for the questions that I get tell me a great deal about investor sentiment and the general tenor of the financial markets. The same is true for the questions I receive daily from our readers.

Lately, the most intriguing questions have dealt with the price of oil and other key commodities. It’s a topic that’s clearly on a lot of people’s minds so I thought I’d share some of them with you today.

Q: With crude oil prices down more than 75% from their record high set in July, do I really need to worry about “peak oil”?

A: Let me be blunt. Producers are operating near maximum capacity every day with 89.5 million barrels per day. We’re using 89 million barrels per day. That means there is essentially no excess capacity anywhere – period. If you factor in war, routine maintenance of pipelines or refining facilities, and diminishing supplies, we’re probably already running at a deficit even though current data does not yet reflect that. There is a very high probability that in the near future demand will outrun supply – and by that I mean permanently outrun supply.

I don’t think this is “just” peak oil. But I do think it’s the investing opportunity of our lifetime.

Q: That sounds alarmist. What about other commodities?

A: There’s a difference between being alarmist and being prepared – and, in this case, we’re talking about the latter especially when it comes to potential profits.

We are in the initial stages of a fight to the death for energy supplies and many other commodities – most notably potable water.

As I’ve noted for years, and as Money Morning detailed yet again in an analysis just last month, China, among other countries, is using its huge currency reserves – and the financial weakness of rivaling other global players – to lock up long-term supplies of commodities. By any stretch of the imagination, I don’t think this is the last we’ll see of this kind of thing.

The bottom line is that the outcome of this battle will affect every nation on earth. Absent truly fungible substitutes, it’s reasonable to expect to see oil nationalized at some level within our lifetime, and the first armed conflicts over water somewhere on the planet possibly as soon as 10 years from now. Certainly there is going to be economic conflict over those two things and on a level that is presently unimaginable. Depletion is happening at a far faster rate than most people realize.

Q: But oil’s still cheap.

A: It’s always been cheap – cheaper, in fact, than a cold soda or bottled water. But at a time when market forces are inevitably diminishing the supply, even as demand continues to grow, we’re looking at a one-way trip over time.

The average American uses two times the amount of oil used by each European, four times the amount used by each Japanese consumer, 12 times their counterpart in China, and 30 times the amount used by the typical consumer in India. And that’s at a point in time when nearly 4 billion people live in complete poverty without the stuff we take for granted…like oil and water.

Supplies are destined to shrink. And until we can find replacements, we’re stuck with what we’ve got – there’s no more of it.

Q: Isn’t the world working on substitutes as fast as they can – having been shocked by record prices of $150 a barrel?

A: Yes. And they’re making good progress. However, even if substitutes were found tomorrow, we still have to replace trillions of dollars worth of manufacturing and infrastructure processes that have to be changed completely. Some studies I’ve seen suggest that oil is used in more than 60,000 manufacturing processes and it’s much the same with water, in particular.

Even the most wildly optimistic estimates suggest that changing to new technology may take another 30 to 50 years to work through. In the meantime, oil is set to run out 35 years from now using the highest-reserve-level calculations available – and that assumes no demand growth and no population change. It’s even worse when it comes to water. Some predictions suggest that by 2050 nearly 7 billion people will live nearly waterless lives.

Q: That’s pretty forceful thinking.

A: I’ve always operated under the philosophy: “If not now, then when? If not you, then who?”

As the investment director of Money Morning, my job isn’t to “force” anybody to think a certain way, or to take a certain action. It’s to analyze the best data available to me, to make the appropriate recommendations, and to provide you with the insights you’ll get nowhere else.

I think we have the opportunity to invest in a group of “real assets” (which I define as oil and other key commodities) at a point when supplies are declining as demand is escalating. That combination suggests very rapid appreciation as demand eventually overwhelms production in the next few years. It’s a rare combination, and that’s why I say it may be the “profit opportunity of a lifetime.”

This reminds me of a conversation that I had with my colleague Jim Rogers, not too long ago, when the legendary investor observed that “real assets represent real wealth.”

I agree. And you will, too.

Original post

Comments

[longoil:]

Excellent article, oil is definitely a "must have" long term investment.

Feb 13 02:00 PM

[Roscat:]

Oil will slowly come back only in 3-5 years for a 5-7 years period. And then, it will die a slow death. Why, you ask?

Because the demand will not grow fast enough, and during this growth there will be substitutes to resolve the temporary energy needs. There may be a good run to about USD80/B until the alternative energies will come into play. Already DE, the Nordics, India, and other countries have realized that without nuclear power they will be practically at the mercy of other countries, or practically dead.

So, I say buy oil now, sell it in 3-5 years and buy U, in my opinion.

Regards.

Feb 13 03:07 PM

[svkoho:]

agree on the general thrust of your arguments except that your production figures are off. Crude production is 74 million B/D and all liquids + crude is 86 Million. Here is a link:europe.theoildrum.com/...

Feb 13 03:38 PM

[PapaWhisky:]

Spare capacity now is closer to 5-6 million bbl/day

Feb 13 04:02 PM

[brain:]

inflation is already driving up pump prices, irregardless of crude prices; this divergence will soon break driving oil much higher in relative terms - $65 - $85 higher.

Feb 13 04:24 PM

[Rob Viglione:]

Any creative ideas on the best way to play oil?

Feb 13 05:05 PM

[Stone Fox C...:]

The amount of oil used by the avg US consumer is an interesting point, but lets not get too carried away. The avg China or India consumer is not going to have a car. Just like in Europe, they are likely to us public transportation so no country is ever going to approach the oil used by the US.

In general though, I agree with your theory and the thoughts of Jim Rogers. We haven't reached peak oil, but we've reached peak cheap oil. Oil can only go up from now until the time when alternatives are available. That might be 5 or 10 or 20 years. And its only gotten worse this last year b/c so many companies have cut back on capital upgrades. Until then stocks like ATW or RIG will be hot. Those long term contracts combined with the equipment to reach where oil does exist. Other stocks like FCSX that help clients hedge commoditiy exposures should outperform. FCSX is much riskier but its down 90%.

Feb 13 05:56 PM

[Jay-Dawg, CDA:]

I agree with this article. Investing in oil effectively hedges your "natural position" in oil. Indeed, almost everything we buy has oil as part of its cost, directly or indirectly. Directly, the easiest examples are your car, bus passes and anything made of plastic. Indirectly, everything that needs transportation (every tangible good, basically) will cost more if the price of oil goes up.

So investing in oil will smooth out your exposure to oil. I tend to think like most people that the price of oil is going up in the long term. Even if it doesn't, there will be great opportunities to make money anyways. Every decade or so some geopolitical event happens (war, for example) that makes the price of oil temporarily skyrocket. By owning secure sources of oil through stock of petroleum companies in Alberta or the US, you are set to profit from such unfortunate events.

Jay

Disclaimer: I own shares of Suncor (SU)

Feb 13 05:58 PM

[phaf:]

Great article; while obvious in a way, the points need to be repeated, and to a broader audience.

I wish Roscat (above) were right, but I think the climb is going to be steep and long term. Stone Fox Capital is right regarding average use per individual, but both China and India are rapidly expanding their middle class, and cars are one of the first major purchases made by those with means.

A shift away from oil will come only after a lot of pain and agony. A meaningful move to alternatives needed to begin 20 years ago and accelerate over time; we have maybe only begun to move across the starting line.

Feb 13 06:28 PM

[thesnowjob:]

Solid article. Oil is a must have core position for medium to longer term. Downside might be $20 but upside could be $200.

Triple bottom at $34 is becoming pretty solid as a base. A lot of people are convinced it is PAPER oil that is driving PHYSICAL oil prices...no different than in precious metals and most commodities IMO.

Feb 13 07:25 PM

[Jake Berzon:]

I agree with the premise - oil is an important commodity to own. However, OIL ETF, which invests in the futures contracts had dreadful performance vs. spot oil as of late. USO did better, but still not as well as the spot prices. What is the best way to own oil then?

Feb 13 07:48 PM

[naidle:]

A lot of predictions in this thread. It's safe to say very few saw the oil collapse coming. Are we so sure we know when it's going to go back up (if it does)?

Feb 13 08:15 PM

[Reachsb:]

I've been accumulating oil as a currency hedge as well as from a supply shortage stand-point. There has been a dramatic drop-off in the output from Oil fields recently. Mexico's largest oil field may be tapped out by 2010. At these depressed prices, a lot of oil from Canadian Tar sands as well as the deep sea drilled oil will start coming off from the market. Shell will look for excuses to cap their Nigerian operations, Chevron can't be making any money from their offshore operations in civil war torn - Angola at these price. Ditto for the Russians drilling in perma-frost Siberia, So we are facing the imminent possibility that more than 75% of the world's oil production will be sourced from a very volatile Gulf region. The entire gulf oil has to pass through the Straits of Hormuz in front of Iran. You'd be foolish to assume that the Iranians won't their best to get on the bad side of Israel to incite the oil markets. I'm sure that the Iranians are hurting with oil at these depressed levels and are having difficulties in balancing the budget.

I believe the markets are being too complacent in the underpricing of oil. The Iran premium seems to have vanished all together. Supply disruptions anyone?

Feb 13 09:54 PM

[aarc:]

This is the eight consecutive month in a row oil has been on a negative side.

Another one of those technical analysis parameters usually forgotten during severe downturns such as when Dow Jones went into meltdown late 2002 producing 8 consecutive negative days before being able to reverse the trend.

Speculative at best but worth the effort when timing becomes the essence during severe chaotic conditions where most technical and fundamental analysis are breaking down.

Feb 14 12:23 AM

[PeteK:]

Stone Fox,
You are wrong.
In China, people dream to have a car.
All those bicycles are left in the backyard getting rusty.
When GM is dying here, cars sales in China still fine.
Go look at it yourself. We did.

Feb 14 04:58 AM

[PeteK:]

Reachsb,
You are quite right. Agree 100%.
It's not a stable world out there.

Feb 14 05:22 AM

[john s. gordon:]

are we really using 89 MMBbl/day ?
how much of that is going into offshore tanker storage waiting for the price to rise?
> jack

Feb 14 08:24 AM

[Ferdinand E...:]

89.5 mb/d for oil production doesn't sound right, and the reserve-production ratio as the author uses it in this article is wrong, but I certainly agree with what is being said. This is an important article, and it deserves a wide circulation,.

Feb 14 08:29 AM

[Boubou:]

During the commodity boom, the argument of burgeoning asian consumption, and supply limitations was often used to explain the high prices. I certainly bought it, to my cost.
Now ,with only a minor and temporary glitch in western consumption, but with the general thesis still valid, energy is practically free.
It spoils your faith in the value of rational analysis .
Hoodathunkit??

Feb 14 08:33 AM

[fatpitch2:]

Demand is one thing... don't forget SUPPLY issues

Demand may be off slightly as a result of the current economic crisis but the emerging world does not all have to buy cars to boost demand ... just imaging say 5% of India and China's population buying an extra gallon of gasoline per week to put in their Moped? In the USA there is 1 car PER PERSON, in China there are roughly 3 cars per 100 people... lots of room to grow.

Now... how about SUPPLY?
I do not believe you will find any reputable source that will tell you that the depletion rate from current oil fields is less than 5%. Many geologists believe it is closer to 9%. Mexico's Canterell field is depleting at double-digit rates. So we have to add say 5M bbl/day just to keep even? With prices < $40/bbl do you think this is happening? I do NOT....

deep water projects are cancelled, oil sands CapEx is being slashed, stripper wells are being capped.... etc.................

When it turns around and as Keith says ... the date is not clear... but when it does... it will get FUGLY fast...

Just my humble opionion.

Feb 14 09:43 AM

[toobad41:]

Oil drives civilization. At least developed civilization. If you think other energy current alternatives will be replacing oil you are dead wrong. Current alternatives are based on old technology and they are not even close to replacing oil. A replacement for oil has not even been thought of yet. I look 50 years from now as the world looked 150 years ago (before oil). But I won't be here to enjoy that simpler life.

Feb 14 09:54 AM

[john s. gordon:]

well in 1850 whale oil & coal & wood & wind power drove civilization.

kerosene from petroleum came along just in time to save the whales from extinction.

liquid transportation fuels from cellulose might help save civilization?

liquid transportation fuels from coal might help save civilization?

our biggest untapped energy source today is hot air from the u.s congress.
> jack

Feb 14 10:11 AM

[john s. gordon:]

boubou - you have seen the effect of speculators & hedgie funds overriding the expected growth in demand from underdeveloped countries.

today with the speculators all squashed like bugs (one can only hope) oil is practically free as you say.

a return to rational analysis would be most welcome.
> jack

Feb 14 10:17 AM

[koolsool:]

The current price of oil is not a supply-demand price. It is a price created by deleveraging hedge funds and speculators dumping oil contracts on the market at any price. The current low price is totally inaccurate.

Feb 14 10:19 AM

[henarl:]

Oil at these prices is a good long term investment. However, with the current economic malaise and the overhanging surplus stored in tanks, tankers, pipelines, and the strategic petroleum reserve, it probably will remain cheap for at least several months. So go long oil, and sell short term covered calls against your positions. Long BPT, XOM, FRO, HTE, KMP, KOG, LINE, MWE, OKS, OSG, PBT, UNG.

Feb 14 01:27 PM

[ROLEX18:]

If it's so scary, why it's so low ?
I will be a buyer of CL futures at 20$-25$ for short term short squeeze spike that I will dump back at 35$.

Feb 14 04:56 PM

[brea:]

absolutely WORTHLESS article. all information is already known.
in addition he NEVER even toched on the what the "must have profit play"
is!!!! the alledged pretext of the entire article he doesn't even discuss.
total waste of time!!!!!


On Feb 13 02:00 PM longoil wrote:

> Excellent article, oil is definitely a "must have" long term investment.

Feb 14 07:08 PM

[simon shain...:]

I think anything related to companies that are involved in the Marcellus Shale development in Pennsylvania will become wealthy. There is a heating oil facility in Berwick Municipality, salem Township,Luzerne County, PA on the Susquehana river that is getting a tremendous amount of activity. i think Range Resources or Chesepeake Energy will joint venture or buy them. They were one of 13 hubs of the NE pipeline of Sunoco. Even there multimillion gallon tank capacity is attractive to water needs to fracture the shale('frac'). they are private, doing a PPM, will go otcbb this summer. Where can I get a PPM prospectus, anyone??

Feb 14 08:50 PM

[Dirk McCoy:]

There is a great deal of oil in shale, deep water, tar sands, etc. that can be pumped out for $80/barrel. And at $80/barrel, new solar (40%+ efficient) and new transmission (<1%/thousand km) technologies are at parity. We won't see a major shift until shortages become imminent, but there will be a lot of solar capacity installed over the next 20 years. And there are breeder reactor technologies that promise even more economical energy.

Meanwhile, it is not impossible that the internet will create a major drop in oil consumption. There is no reason for many workers to go into their downtown offices today. Cars are going to continue to become more efficient, ride sharing could be more widely used if an ebay/craigslist type application gains popularity, and continued urbanization means more public transportation (running on alternative energy), not less.

I'm sure oil will go up as the dollar weakens and consumption recovers, but there are lots of people on the other side of this belief, which is why oil's equilibrium- even six months out- is well below $60/barrel. And add a serious long term recession on top of the factors I mention above, and it's not impossible that oil could return to the levels it's been at for most of the the past 30 years, not up much from here.

Feb 16 09:28 PM

[wackyfunster:]

An interesting article I read attributes the effect to rolling future contracts vs. the substantial contango that now exists in oil futures:
finance.yahoo.com/news...

It makes sense to me, but I honestly haven't dug into it any further. Hope this is helpful.




On Feb 13 07:48 PM Jake Berzon wrote:

> I agree with the premise - oil is an important commodity to own.
> However, OIL ETF, which invests in the futures contracts had dreadful
> performance vs. spot oil as of late. USO did better, but still not
> as well as the spot prices. What is the best way to own oil then?

Feb 16 11:36 PM

[Pax Americana:]

Stupfeing, when one actually pens the paragraph.!

Oil is set to run-out in "35 years", using the highest -reserve-level
calculations, available, and that not factoring in demand growth!
trully mind boggling.

Jun 20 07:08 PM