Oil, Natural Gas Priced Below Replacement Cost

Current buy recommendations including Total (TOT), ConocoPhillips (COP) and EOG Resources (EOG) have undeniable long-term appeal, we believe, while oil and natural gas are priced below replacement cost. Economic growth requires new supplies of energy. Even flat economic growth requires new energy supply after normal decline reduces existing capacity below demand. No significant amount of new producing capacity can be justified at the average quote for the next twelve months of $4.72 a million btu for natural gas or $54.32 a barrel for oil.

Yet stocks of buy-recommendations are priced as though the long-term price were the same as one-year futures, or less, as we analyze it. More likely the price to justify large scale new investment in natural gas is closer to $8 where the average futures price for the next six years has traded since 2005. For oil, the price may be above $75 a barrel that we use as the long-term price before adjustment for inflation in our estimates of Net Present Value (NPV) for each stock.

As to when stock prices might be on trend to reflect replacement cost, we look to the ratio of stock price to 200-day average as one clue. On that basis, one stock in all our large cap coverage qualifies, hold-rated CNOOC Limited (CEO). We are watching for an appropriate time to change our recommendation to buy. Investors acting on our current buy recommendations continue to need patience in realizing rewards.

Originally published on April 21, 2009.

Comments

[rhokin:]

Isn't the cost of replacement also a variable?

May 12 08:37 AM

[Ferdinand E...:]

Sorry, but on the basis of a very careful look at oil price expectations and the investment plans of oil producers 5 or 6 years ago, I have a problem believing that $54/b is a catastrophe for most producers. It's a lot more than they thought that they were going to get at the present time.

May 12 10:00 AM