Voices About Oil

There are conflicting voices about oil. Some say too much is available and demand is falling. Others say demand is rising and reduced exploration will contribute to a new boom. Some say oil is responding to the equities rally. Charts show oil with upward tendencies weeks before equities began to rise.

Here are some important media snippets with mixed bullish and bearish messages:

(April 9 Wall Street Journal) U.S. petroleum inventories sit at about 360 million barrels, their highest level since 1993, … McKinsey [report] suggests that energy demand may snap back more quickly than many observers project, driven by strong demand growth from developing countries. …If the world economy returns to moderate growth, energy demand will increase about 2.3% a year between 2010 and 2020, nearly a full point faster than the period from 2006 to 2010 … Developing regions will account for more than 90% of the growth, led by the Middle East.

(April 9, Bloomberg) Crude oil rose more than $2 a barrel as equities gained, signaling that some investors expect economies to stabilize, bolstering energy demand.

(April 10, US Department of Energy - Energy Information Agency) The global economic contraction continues to depress energy demand. … The annual price of West Texas Intermediate (WTI) crude oil averaged $100 per barrel in 2008. The global economic slowdown is projected to cut these prices by more than half, to average $42 per barrel in 2009 and $53 in 2010—forecasts slightly lower than last month’s Outlook. … Following the sharp price decline that occurred during the second half of 2008, the global oil market has remained relatively stable since the beginning of the year. This situation is expected to continue through most of 2009, until economic recovery in the United States and elsewhere leads to a rebound in oil demand growth. … The future direction of world oil prices in the short-term will largely depend upon the timing and pace of the recovery of the global economy.

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World Traded Weighted Oil Prices 1978-early 2009

(April 10, Wall Street Journal) Most of the total 1 million barrel-a-day downward demand revision came from weakness in big oil-consuming nations like the U.S., though sluggish consumption is clearly deepening in emerging markets like China, the world’s second biggest oil consumer after the U.S. … China’s oil consumption — previously expected to register small growth in 2009 — is now expected to fall by almost 1% for the first time in 19 years,

(April 11, Wall Street Journal) Chinese demand for raw materials, hard hit in past months, is showing signs of recovery, with crude-oil imports hitting a one-year high in March, the government reported Friday. Steel mills in March imported record quantities of their key raw material, iron ore, in anticipation of a pickup in demand in coming months.

Relative Performance Charts:

The 1-year daily chart below plots price performance of crude oil and of crude oil versus the US stocks (SPY), Chinese stocks (FXI), copper, aluminum and natural gas.

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Where We Stand:

We like owning physical crude oil through royalty trusts that pay cash distributions, as opposed to owning futures contracts or futures funds for crude oil. There is no expiration date on royalty rights. The cash flow is consistent with our equity income orientation. The reserves of the wells increase as the price of oil increases due to the ability to afford more expensive extraction methods. Technology improvements can increase reserves too.

It is true that oil royalty trusts are wasting assets, but so too are futures contracts. There is nothing that can extend the life or number of barrels of a futures contract, but the life and number of barrels in a well can and generally do increase when oil prices increase.

The interest earned on the collateral behind futures accounts is consumed by management fees in oil futures ETFs such as USO or USL, and the interest earned on collateral by those investing directly in futures contracts is much lower than the cash flow from the royalty trusts.

To each his own, of course, but we are comfortable with royalties.

Our favorites have been Prudhoe Bay Trust (BPT) and Canadian Oil Sands (COSWF.PK), and we own both.

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Relative Performance: Crude Oil, BPT and COSWF

The two trusts have different gearing to the change in the price of oil. BPT has a break-even around $14 per barrel, whereas COSWF has a break-even around $36 per barrel. That means, for example, if oil goes from $52 to $57, the margin for BPT goes from $38 to $43 per barrel, whereas the margin for COSWF goes from $16 to $21 per barrel — different rates of change.

Unfortunately, we will probably eventually move away from COSWF due to the combined issues of new Canadian tax rules that will force the trusts to convert entity form and begin paying corporate taxes in 2011; and the recently expressed position of the Obama administration on greenhouse gases that will likely further reduce the profitability of oil sands. We will wait to see how things pan out, but are concerned that Canadian oil sands will lose a good deal of their appeal, as the comments below from Petroleum Intelligence Weekly illustrate,

(April 13, Petroleum Intelligence Weekly) Oil Sands Not Part Of Obama’s Green Vision … Synthetic crude [provides] 8% of overall US crude imports, but the production of this crude involves 15%-40% higher greenhouse gas emissions per energy unit than conventional crude. This puts the oil sands on a collision course with the Obama administration, which wants a gradually tightening cap on greenhouse gases in order to cut emissions by 14% by 2020 and by 80% by 2050, using 2005 levels as a starting point. To do this, the White House is supporting legislation that could derive hundreds of billions of dollars per year from carbon trading, starting with a price on carbon at around $20 per ton … Obama has indicated that a US cap-and-trade policy would affect Canadian oil sands producers the same as the US oil business.

Summary:

Oil we believe is the new gold, and is the closest thing to a global currency. Societies will hack away at its share of world energy, as they must, but for a long, long time oil will be in short supply over full business cycles.

The current price in the low $50’s is below the cost of replacement from deep ocean wells which reportedly is in the vicinity of $70.

The carbon tax penalties on oil sands will only add to the global average cost of producing oil, which will increase the profits for those who own proven reserves of conventional liquid petroleum.

We own oil in royalty trusts and expect long-term rising cash flows from them. We are also more comfortable riding out potential new downward stock market movements in oil trusts than in corporate stocks.

Comments

[Richard Shaw:]

COSWF -- normally we do not recommend Pink Sheets companies, and in fact normally recommend strongly against them.

In the case of Canadian Oil Sands, COSWF is a Pink Sheets company, but the company is listed on the Toronto Stock Exchange. Unlike the typical Pink Sheets company, it provides a great deal of information, files extensive regular financial statements that are readily available.

It is a royalty partner and the largest shareholder (36.7%) in the largest oil sands project (Syncrude Ltd www.syncrude.ca) which is majority owned by major names in the oil business, among which are Exxon, and Conoco.

There are listed shares traded on the TSE (COS.UN), but COSWF traded in the US is a "clone" and is moderately liquid with about $2.5 million in average daily trading volume. Website www.cos-trust.com/

The typical Pink Sheets company does not provide much information, is a penny stock, has limited to negligible liquidity, is not followed by analysts, and may not be substantial or successful. Canadian Oil Sands does not have those characteristics. They are followed by analysts from Bank of Montreal, CIBC World Markets, Credit Suisse, Merrill Lynch, Raymond James , UBS and others.

Our view of Pink Sheets companies generally is to avoid them unless there are clear attributes that make them acceptable, as in the case of Canadian Oil Sands.

Apr 13 07:55 AM

[Ferdinand E...:]

'Oil is the new gold and the closest thing to a global currency'. Hmm, I thought I have have heard a great deal about oil, and of course know a great deal, but that slipped by me. However, instead of saying _____, I'll say that it is an interesting idea that deserves to be carefully examined.

Apr 13 09:38 AM

[dcb:]

great article, different approach. I have been aware of the limitations of the etf like OIL. not for me. easy to manipulate prices before a roll over. I rad somewhere there is more outstanding OIl shares than their is oil to cover those shares.

Apr 13 06:08 PM

[tagthatstock:]

paying alot of money for BPT considering their 'reserves' are dropping too fast,,,,,as for COSWF im an not at all against otc/pinkies,,,,just know that you never trust a canadian book,,,,ZINC will be the 'gold of the future' the science has been around for decades and there is a world glut of it. zinc is a 2 sided energy source. as a 'solid' as in solar and as a consumable as in 'oil'.

Apr 13 07:37 PM

[Repsonsible...:]

This is the Interview that got Dylan Radagin FIRED from CNBC 3 weeks ago , He Tells the REAL TRUTH ABOUT THE TRUTH ABOUT THE BANK CORRUPTION GOING ON NOW , He was about to start Investigating the Bailout Money Transfer rom AIG of $180 Billion to Goldman Sacs but he was fired the day before and I fear he's in REAL Danger from the POWER Players on Wall Street and Washington .
heres the link fedupusa.info/Dyla......
pass it on ! Apr 13 10:35 PM |Report abuse| Link | Reply 00

Apr 13 10:36 PM

[Repsonsible...:]

This is the Interview that got Dylan Radagin FIRED from CNBC 3 weeks ago , He Tells the REAL TRUTH ABOUT THE TRUTH ABOUT THE BANK CORRUPTION GOING ON NOW , He was about to start Investigating the Bailout Money Transfer rom AIG of $180 Billion to Goldman Sacs but he was fired the day before and I fear he's in REAL Danger from the POWER Players on Wall Street and Washington .
heres the link fedupusa.info/Dyla......
pass it on !

Apr 13 11:21 PM

[oldman:]

isn't canada still taxing distributions in ira's?

Apr 14 05:26 PM

[enviro111:]

BPT has a really limited life due to the massive depletion of prudhoe bay. the current high price for BPT doesn't allow for the massive depletion. The high yield is really a mirage.

COS on the other hand is cheaply priced, has massive reserves, and is politically safe in Canada. Oil is likely to rise from these depressed levels and COS will resume their high dividends.

Obama is not likely to go after the Canadian oil sands. I think in a few years, the USA will be scrambling for what ever oil it can get and it will not have the luxury of boycotting canadian oil sands because they produce a lot of CO2 emissions versus conventional crude. Also, in a few years, Canada's conventional crude production will be low enough that they will be forced to keep most of their oil sands production at home. They are mitigating the CO2 problem by building windmills (suncor). Politically, oil sands will have few enemies in Canada.

Apr 14 05:37 PM

[tagthatstock:]

still surprised this stock is up, their reserves have been whacked in halfish and having cramer love it the same thing as saying you like lard for salad dressing. people paying $65 for a stock worth $38 tops is funny)- tighter math figures BPT is worth about $20

Cramer says BPT is similar to Permian Basin Trust which is up 27% since his recommendation. He prefers BPT, which is a pure play on oil whereas PermianBasin has natural gas exposure.

(PBT $9.20 prolly worth a gander after wallstreets calendar flips over to May 1---might get the stock for $5ish once these early to the party traders get stopped out.)

Apr 28 07:42 AM