Oil Is Still the Key to U.S. Economic Future

by: Michael Fitzsimmons

Recently there has been a plethora of articles in the financial press, including SeekingAlpha, intimating the weakness of large integrated oil companies based on the last couple quarterly earnings reports. Most of the authors of such articles have a very short memory and obviously need a reality check. I'm happy to oblige.

Naturally companies like ExxonMobil (NYSE:XOM), British Petroleum (NYSE:BP), ConocoPhilips (NYSE:COP), and Chevron (NYSE:CVX) reported lower earnings. After all, oil had dropped from $145/barrel to around $40/barrel and the price of natural gas has plummeted. Did anyone not expect earnings to be significantly lower? However, the question is not what earnings are today, but what will the oil company earnings be in future quarters next year and the year after?

Let's take a look at the history of world oil prices.

World Oil Price HistoryClick to enlarge

Obviously the price of a barrel of oil has been cut in half from the high of $145/barrel reached in 2009. After dipping below $40, oil is now trading over $70/barrel. People are talking about how cheap oil is only because they are looking at the 50% drop from the highs. However, they forget that a mere 5 years ago, oil was trading in the $30's and many economists were predicting the US economy would not survive $50/barrel oil. Now, here we are today with oil at $70/barrel and psychologically folks are thinking it's cheap. Whew - gasoline is only $2.50/gallon rather than $4.50! Well, oil is up over 100% the last 5 years. Meanwhile the US is going bankrupt enacting financial policies in a wrong-headed attempt to deal with a commodity based problem (oil).

Since oil has more than doubled over the last 5 years, and at one point was up nearly 500% ($30->$150), is it any surprise that the S&P500 is flat over the last decade? That index is actually negative when one takes into account dollar depreciation and inflation. At the same time, energy company investments are up over 10% annually during this S&P500 "lost decade". Imagine the performance of the S&P500 with the energy stocks removed from the index. It would be horrendous.

Was it any surprise to see the American automanufacturers struggle after oil went to $145/barrel considering they only make cars that run on gasoline? It's amazing that Americans and American policymakers are already forgetting $145/barrel and the role it played in the economic, fiscal, and US equity market debacle of the past year and from which we are still suffering.

The financial press is likewise being fooled and acting like energy companies are losing money. Yes their earnings are down, but they are still making money. Their net incomes are *positive*. Unlike the banks and insurance companies, the oil companies made money without any assistance from the US taxpayer. The latest quarterly earnings were positive despite oil dipping below $40/barrel and very low natural gas prices. Now oil is at $70/barrel and so earnings will therefore be trending higher from here.

Unlike US natural gas prices, oil prices are not down due to some new huge source of supply coming online. Oil prices are down simply because of demand destruction due to the worldwide financial crisis. Once worldwide government economic stimulus policies take hold and reflate the world economy, oil demand will come roaring back. Meanwhile, most energy companies have cut exploration and production budgets. Does anyone really believe oil prices will stay "low" much longer? Apparently some of these financial journalists do. I certainly do not.

US Energy Policy

Despite all the rhetoric from President Obama, US energy policy is still non-existent and what does exist is abysmal. Certainly we have some solar and wind initiatives, but they generate electricity - not gasoline, and America is hooked on gasoline as foreign oil fuels our transportation sector. "Cash-for-clunkers" is being touted as a great success, and I suppose from a short-term economic perspective the program has stimulated car and truck sales, which is a good thing. However, the cars and trucks being sold still run on gasoline. If one judges American energy policy by how much it reduces foreign oil imports, I give Obama's energy policies a D-. The US is still dependent on foreign oil imports for 60-70% of its consumption and there are no policies in place to significantly loosen the rope that continues to tighten around are necks.

Meanwhile, the US's best competitive advantage in the worldwide economy (it's abundant, clean and cheap natural gas supply combined with its 2.1 million mile natural gas pipeline grid) is being underutilitzed and ignored by US policymakers. US natural gas production is so high there is little spare capacity left to store additional reserves ahead of the winter heating season. Folks in states wise enough to support natural gas transportation are paying substantially less on a gallon equivalent basis than the nationwide $2.50/gallon gasoline price: in Oklahoma, the price of natural gas is $1.11 GGE; in Utah it's $0.96 GGE. Despite the fact that US produced natural gas prices are less than half of foreign imported oil derived gasoline, the US Congress and American people still don't seem to "get-it" that US produced natural gas is the solution to the economic, environmental, and national security problems facing our country. How can a country that is home to colleges and engineering schools like MIT, Stanford, CalTech, Georgia Tech, University of Illinois and Berkeley miss such an obvious policy? Answer: oil and coal lobbying money and a Congress that is bought and paid for.

Meanwhile, hope springs eternal with HR 1835, the so-called natural gas act. We can only pray this doesn't die a quiet death in the Senate, where so many good House resolutions end up in the trash can. Please contact your elected officials and ask them their position on HR 1835 - are they a co-sponsor? Do they support it? Let them know if they don't support this bill you will not be voting for them in the next election.

Environmental Misperceptions

"Environmentalists" continue to make the mistake of lumping natural gas into the fossil fuel camp along with oil and coal. Although natural gas is indeed a fossil fuel, there are indications that natural gas has non-biological origins as well. Read Robert Hefner's book "The Grand Energy Transition" for a detailed discussion of this topic. Regardless, so-called "environmentalists" continue to get it wrong: natural gas emits 50% less CO2 than does coal and has none of the toxic particulate remnants. Prudent energy and environmental policy would therefore be to use natural gas for electricity generation and shut down the coal plants. Natural gas is also much cleaner and cheaper than gasoline, so again, prudent economic, energy, and environmental policy would be to use natural gas in the transportation sector. However, most "environmentalists" oppose using natural gas simply because they lump it in as a "fossil fuel" and those are just "bad". Lacking other realistic alternatives in the short term, these "environmentalists" are therefore actually supporting continued burning of coal and gasoline (oil). Ironic isn't it? What we need is a realistic and pragmatic energy policy like this one.

Bottom line to the investor is this: the US is making NO significant progress in weaning itself off of foreign oil imports. In an era of peak oil, worldwide supply will not keep pace with worldwide demand once the world economy recovers. In addition, oil is priced in US dollars and the outlook for that currency, in my opinion, is weak. For these reasons, US investors should be investing in energy stocks - they are still very cheap for anyone with an horizon longer than a few quarters. My favorites energy investment recommendations continue to be BP, COP, CVX, XOM, Petrobras (NYSE:PBR), StatOil (NYSE:STO), Schlumberger (NYSE:SLB), and Transocean (NYSE:RIG). In the so-called "alternative" energy company space I like Fuel Systems Solutions (NASDAQ:FSYS) and Westport Innovations (NASDAQ:WPRT). I like these not because of US energy policy, but because foreign countries do "get it" and are making the transition to natural gas transportation. WPRT is reporting earnings this Thursday.

Disclosure: the author owns COP, PBR, SLB, STO, and WPRT.