I like to give actionable advice, and there will be some investing ideas and suggestions throughout this article. But let's look at the big picture first.
To an oil man, natural gas should be flared off or farmed out. Yes, of course, gas is an important resource. Perhaps Michael Fitzsimmons is right, and we should subsidize retail distribution of compressed natural gas (CNG) to power bulldozers, airplanes, motorcycles and lawn mowers. If enough people get behind an idea, there's nothing to stop a government mandate, no matter how nutty. Synthetic jet fuel? Zero emission hydrogen-powered cars? Carbon sequestration? Oil from algae farms? Uh, okay. Whatever pipedream miracle you can sell a Congressman makes equal sense if your purpose is to loot the public purse and pocket a subsidy, like GM or AIG or C.
Oil men don't give a damn whether the billions they pay in royalties and taxes are wasted. We're busy looking for 40 API crude -- not gas, not condensate (very light Natural Gas Liquids); not tar sands, coal seam methane or asphalt; not super heavy or sour or tight formations that have to be acid fracced and drilled horizontally in ultradeep water as a novel engineering experiment.
What oil men want is a big porous, permeable sandstone or carbonate, charged by rich organic shale downdip, with a structural or stratigraphic trap that was in place before the oil migrated. It could be an "elephant" or a little reef with a couple million barrels in place. Onshore or offshore doesn't matter. That's purely a question of scale. But the objective has to be light sweet oil. We need to produce 73 million barrels a day, rain or shine, recession or no recession.
This chart comes from Rembrandt Koppelaar. Conventional crude provides 91% of the 475 trillion BTUs of energy we consume every day from liquid hydrocarbons. Condensate in old gas fields contributes 7%. Corn and sugar cane are 2%, most of it used in Brazil. If you deduct government subsidies and sunk costs of oil & gas exploration, which happen concurrently, crude oil pays the whole freight of modern transport and about half of all industrial output. Zero out oil and nothing works. No mining, shipping, manufacturing, mechanized farming, distribution, construction.
The industrialized world is called industrialized because we consume 2/3 of the world's crude oil production and because we leapfrogged everyone else in political stability and rule of law. Laugh if you want to, but privately-owned Western oil companies grew into global giants because they were domiciled in jurisdictions that respected contracts and share equity. Exxon (XOM) and Shell (RDS.A) are strong enough financially to write off losses in Russia, Iran, Indonesia, Latin America, etc. because their corporate roots are deep and thick, over a century of compounded investment and know-how.
The blue shaded areas are OECD industrialized wealthy countries. They produce about 1/4 of total world oil supply and consume 2/3 of global production. This lop-sided equation is particularly scary in Japan, Korea, Germany, France, Ireland, Switzerland, Austria, Poland and Turkey because they produce 1% and import 99% of their oil supply. The United States domestically produces about 29% of its baseline conventional oil demand. We rely on Canada and Mexico to ship another 10% of US supply. But more than 60% of US and 75% of all other OECD conventional oil supply comes from OPEC, Russia, and former Soviet states like Kazakhstan.
OPEC home consumption continues to rise each year, to quench infinite demand for super-cheap subsidized gasoline, electric power generation, prestige national flag carrier jet fuel, construction, desalination plants and petrochem feedstock. In the next decade, Persian Gulf exports will decline slightly faster than predictable natural decline of their ancient oilfields.
Note that South America (ex OPEC-member Venezuela) and China have marginal surpluses, and that there is a mysterious black segment on those pie charts that I can't explain in detail. Southeast Asia, Central Asia and Miscellaneous Africa are part of the story. But there is considerable noise in the data complied by EIA and IEA. Chinese production is continually revised up, up, and down again.
However, two trends are very definitely established by highly reliable production data, the first of which is Saudi Arabia's role as a "shock absorber" within OPEC.
As you can see from this chart, Saudi increase/decrease in oil production moves the total OPEC output almost barrel for barrel, moderating supply and demand fluctuations to accommodate buyers and to facilitate rolling supply agreements -- which explains why the US turns a blind eye to Saudi political repression and treats the Kingdom as a military ally. Here's a list of the weapons we sold and a recap of US strategic involvement.
Left to their own devices, the doofus Saudis would have collapsed Ghawar ten years ago. It's kept alive by Western engineers led by Dick Cheney's Halliburton (HAL). That's my first actionable stock pick at any price you like. I agree with Matthew Simmons that the Saudi reserves are in decline. All the more reason to buy and hold Halliburton.
Speaking of fields in decline, trend #2 is a trainwreck.
At least half of the North Sea's recoverable reserves have been produced. The probability of finding and producing another 20% is less than 1. The probability of producing every drop of oil-in-place is zero. Ditto Mexico, except that there's the additional insurmountable problem of Pemex, perhaps the world's worst National Oil Company (NOC), although Pedevesa became a serious rival for that distinction when they fired 15,000 US-trained technical staff and managers, and replaced them with politically correct Chavez supporters. So it goes in the Land of NOC, from oil prospect to prospect around the world. If you want to kill a discovery or a producing oil field, nationalize it.
Nigeria is an especially sad story. Half of its potential was nationalized and looted. The US majors know that there's more exploration to be done in the prolific Niger Basin, but their platforms, pumps and pipelines are being broken down by armed gangs and "bunkering" thieves. No one trusts the Nigerian Government. No one wants to work there. Game over.
So, are there are any other prospects to explore?
I've warned on PBR repeatedly, and I think you're a chump unless you play it as a momentum trade. Price volatility in Chinese NOCs Sinopec, PetroChina (PTR) (aka CNPC) and CNOOC make these a crap shoot, unless you have insider enlightenment a day before market swings. China's oil companies will do well in the long run, but I wouldn't buy and hold. Ditto Russian super-majors. The only way to make money in Russia is to have a crystal ball at the Kremlin.
I think it's instructive that Exxon, Shell and BP all got screwed big time in Russia, about $10 billion each (so far). When you consider that their primary source of new oil reserves was a flurry of M&A in the last couple decades, when it was easy to inflate assets, and that -- surprise! -- production agreements with Russia aren't worth the paper they're translated on, one wonders if our integrated US/UK privately-owned International Oil Company (IOC) model is broken? It might be. Exxon quit the downstream retail gas station business. Prudhoe Bay is kaput. Petrobras (PBR) loses money on every tank they fill with ethanol. There hasn't been a new US refinery built in 30 years. Marathon waited years to get planning permission to cook Canadian heavy.
National champions Total, ENI, Itochu, and Wintershall are equally vulnerable. I can't comment on Conoco or Hess, but look at billions invested in ultradeep Gulf of Mexico (GOM), do the arithmetic and figure out how much production it will take to achieve payback. Remember we're talking about oil -- not gas or condensate.
I don't have any position in oil company stocks but if I was tempted to invest I'd buy the Canadians, especially Husky on arctic exploration projects. Cairn Energy has a block or two in Greenland. But this is absolutely *not* a meaningful aspect of the oil & gas industry investment picture. The world needs $2 trillion in new capital expenditure to maintain our current level of 73 million b/d for another decade, after which peak oil will slowly and inexorably trim global production. Most of that capital investment will flow from China and Japan to badly-run NOCs, starving Western majors again.
This is an extremely important issue. Proven oil reserves and oil production at ALL of the Western investor-owned majors flatlined and began to decline during the past few years, which explains why they started throwing money around like casino gamblers in Russia, the Caspian, China, Brazil -- regardless of prospectivity or political risks. With the collapse of oil prices from $140 to $50, their budgets have been hammered, hiring has been frozen, projects shelved. There is a real sense of crisis in the oil business. We bumbled along with low prices before, in the 80's and 90's, but there has never before been anything in the Oil Patch as utterly adverse financially as the present, and another round of merger consolidation won't solve the problem.
The Cheney Plan was to conquer Iraq and give each of the majors a piece to develop. It didn't work, and it can't be done. Iraq is going NOC, probably in partnership with the Chinese. Ditto Brazil, pawning its offshore proved and imaginary pre-salt reserves to China. Watch them wrap up Africa next. Algeria and Libya would love to kick out the Americans (again) and tighten the thumbscrews on Europe.
The White House will bumble along, chasing photo opportunities and tolerating corruption, smiling at bonehead dictators and bowing to make-believe Kings, until and unless the United States adopts a rational Oil Policy.
It goes something like this.
Drill, baby, drill -- starting with the Michigan Formation in Lake Huron and St. Peter sand under Lake Michigan. Open the Outer Continental Shelf (OCS) and state waters of Carolina; the Santa Barbara California OCS; Eastern GOM; and western coastal waters of Alaska. To hell with polar bears. To hell with royalties and triple taxation, too. Reward US oil exploration and production. Drill the BLM Permian Basin pronto, no matter what the allegedly archeological impact is.
Obviously natural gas, coal and nuclear are important. I'm not claiming that oil is the *only* energy we need to develop for our future security and prosperity. But oil is irreplaceable as a transportation fuel. There aren't going to be any coal-fired fighter jets escorting Obama's 747, or CNG-powered Freightliners on I-80 hauling food to Chicago and Altoona. Not today, not tomorrow, not ever.
Disclosure: Author holds no positions long or short in energy