What Rising Oil Prices Mean for Energy Investors

It’s the oil industry’s version of War and Peace.

I’ve spent this week poring over the 2009 volume of the International Energy Agency’s (IEA) World Energy Outlook.

All 698 pages of it.

And what I’ve read so far sends shivers down my spine. Let’s start with the good news…

Temporary Relief From Rising Oil Prices

According to this year’s report, the recession and financial crisis gives us temporary relief from the fossil fuel demand and rising oil prices. Indeed, 2009 will be the first year since 1981 that global energy use will actually fall.

Unfortunately, that’s where the good news ends. From next year, fossil fuel use – and oil in particular – will ramp up again. Consumption is projected to grow by 1% per year through 2030. And you can blame it on skyrocketing demand from emerging market countries.

And it’s this resumption of demand – coupled with a possible shortfall in exploration and production – that’s a recipe for disaster.

The Oil Industry & The Paradox of Oil Prices

From the IEA’s World Energy Outlook:

"Any prolonged investment downturn [in oil exploration and production] threatens to constrain capacity growth, eventually risking a shortfall in supply. This could lead to a renewed surge in prices a few years down the line, when demand is likely to be recovering and become a constraint on global economic growth."

This, dear reader, is the paradox of oil prices – and it’s playing out right in front of us right now.

• During “normal” economic times: rising demand leads to increased investment in exploration and production. The end result is that supplies eventually increase, and prices subsequently drop (or go up less rapidly).
• During recessionary periods (like today): unemployment rises. And the unfortunate people without jobs drive less and demand for oil consequently drops. This also causes a supply glut and a subsequent drop in oil prices.

In 2008, we saw a situation where oil prices fell all the way down to $35 before the OPEC cartel managed to cut supplies enough to cause prices to slowly rise. But the damage was already done.

Result: exploration came to a virtual standstill. Rigs were mothballed. Drill ships were anchored – not in thousands of feet of water, but floating idly in harbors across the world.

Today, we’ve got tight credit markets thrown into the mix. And even with demand returning, investment in new exploration and production will slow. In fact, that’s already happening. According to the IEA, 2009 will see a 19% cutback in oil and gas investment. That’s $90 billion that won’t be going into finding more oil and gas or bringing new finds into production.

My friend Rick Rule likes to put it this way:

“The cure for high prices is high prices and the cure for low prices is low prices.”

Of course, the effects of this phenomenon vary widely between companies and a large part of it depends on production costs. Let’s take a closer look at what makes up the cost of a barrel of oil.

The Oil Industry’s Three Components of Oil Extraction

Extracting oil out of the ground to the pump at your local gas station is essentially divided into three components by the oil industry:

• Finding costs: These are those costs associated with actually finding an oil deposit, determining its size (and thus its commercial viability) and developing the field. According to data from the Energy Information Administration (EIA) this component can vary widely – from $4.77 a barrel in the Middle East to $49.54 for the U.S. offshore.
• Lifting costs: These are costs associated with physically bringing the oil to the surface. The characteristics of the reservoir, its depth and the actual consistency of the oil are the main factors affecting the cost of producing the oil. According to the EIA, lifting costs can range anywhere from $3.87 a barrel in Central and South America to $10.00 a barrel in Canada (oil sands).
• Total upstream costs: This includes transporting the crude, refining it into finished products and transporting and distributing those to end use points.

Today, more oil is coming from deeper and deeper locations, which results in higher finding and lifting costs. You can see this trend in the graph from the EIA.

So what does this mean for investors?

Simply put, with oil prices currently hovering around $80 a barrel – and set to rise – oil companies are beginning to pump money back into finding more oil. That’s good news for the companies who drill for it.

Three Oil Companies That Stand to Benefit From Rising Oil Prices

Here are three companies within the oil industry that stand to benefit from rising oil prices…

• Atwood Oceanics, Inc. (ATW) is an international offshore driller. The fact that its shares have soared by 159% since the beginning of 2009 signals a return to exploration and production by the major oil companies. Still, with a P/E ratio just over 9, it offers investors a good opportunity to play the offshore drilling space.
• Superior Well Services, Inc. (SWSI) is engaged in technical pumping and surveying services. It operates from 36 centers across the United States and has a fleet of 1,628 vehicles. It also provides for, and disposes of, fluids used in hydro-fracking of oil and gas wells.
• Weatherford International Ltd. (WFT) is a larger and more diversified version of Superior. Operating in over 100 countries, Weatherford provides services and equipment used in the drilling, evaluation, completion and production of both oil and natural gas wells. Weatherford shares are up 72% this year.

In summary, with oil prices set to rise over $100 a barrel next year, drillers are benefiting from some of the major oil companies who are once again starting to crank up their exploration and production budgets.

Comments

[Davewmart:]

You think the IEA report is scary?
Check out Uppsala University's analysis of that report.
tsl.uu.se/uhdsg/Pu...
The IEA is looking way too OPTIMISTIC on oil supplies.

So why are they saying that oil supplies will be easier than the Uppsala University can find as justifiable?

It boils down to the IEA raising the assumed depletion rates for fields without saying why, which would mean that more oil would be available faster.
Note that the Uppsala University posits similar depletion rates to those in the past - the least hypothesis - and comes out to total production FALLING from around 85mb/d to around 75mb/d by 2030, which has profound implications for economic growth -as the text remarks the correlation between oil use and economic growth is pretty much 1:1, so little if any growth in the West is likely until we can delink from oil.

The IEA had given oil supplies in 2030 of around 101mb/d, so from an increase in supply if you don't make the entirely unexplained leap in predicted exploitation rates, we go to a situation of absolute decrease of around 13%

This is in the context of a population which will increase from around 6.5billion to around 8.5billion over the same time period.

Putting the numbers together, that gives us a per capita oil supply of around 2/3rds of present supplies.

The oil remaining exporters and Bric countries will likely increase their share of consumption at the expense of everyone else.

Next to the very poor countries, the biggest losers are likely to be Western countries, as that is where most oil is used.

Best placed Western countries may include France, which due to it's heavy use of nuclear power and very good public transport system has already made part of the transition which others will have to slowly and painfully follow.
Sweden, with it's combination of nuclear and hydro power, is also relatively well placed.

Nov 13 05:54 PM

[sethmcs:]

2030? We will all be driving solar powered electric vehicles. IEA is nothing more than oil marketing firm. Oil is going down.

Nov 13 06:16 PM

[Snitzer:]

S/A's lunatic fringe quotient seems to be rising.

Nov 14 09:41 AM

[a. palmer jr.:]

Agree with Snitzer.

Nov 14 09:58 AM

[jerrydd:]

To those who think oil production is going up, please tell me where it is going to come from and cover the present dying oil fields too?

At about $120/bbl many alt fuels from NG, biofuels to Electric become not just viable, but far cheaper. And oil will be there by this time next yr.

Nov 14 10:39 AM

[Juan Carlos...:]

I`m afraid there is a confusion here in the use of standard technical terms in the oil industry. As far as I know, the sum of finding and lifting costs would indeed be total upstream costs, whereas what the author calls total upstream costs would in fact be total downstream costs

Nov 14 11:35 AM

[auto44:]

And where will all that elect. come from? I wouldn't bet on electric cars being any more than a fad led by the Bambi intellect green nut bunch which is unfortunately a large segment of modern society. Studebaker made electric cars in the early twentieth century. They were a fad then and they are a fad now. By time our gov't smartens up and stops throwing money at toys like wind mills and solar panels and starts supporting using nuclear and nat gas power nothing is going to really get better in energy dependence and costs. Wow what a concept.


On Nov 13 06:16 PM sethmcs wrote:

> 2030? We will all be driving solar powered electric vehicles. IEA
> is nothing more than oil marketing firm. Oil is going down.

Nov 14 12:11 PM

[auto44:]

We are here to hear opinions on financial matters, hopefully not to judge other folks who contribute. Attacking ideas is one thing attacking individuals is another.

On Nov 14 09:41 AM Snitzer wrote:

> S/A's lunatic fringe quotient seems to be rising.

Nov 14 12:16 PM

[Advill:]

JAJAJA.....the best scenario is keeping pace with demand, assuming 100mb/d in 2030 ( something achievable in volumen having all the last fields in production) that will keep situation as it is today, barely a balance.

It can be some very short periods of abundance, specially in USA (weeks only) because of refiners particular situations that's all.

I could like to share a contrarian approach in this matter but is not the case.

Rgds


On Nov 13 06:16 PM sethmcs wrote:

> 2030? We will all be driving solar powered electric vehicles. IEA
> is nothing more than oil marketing firm. Oil is going down.

Nov 14 05:10 PM

[Advill:]

From 2010 to 2019 there is a list of new fields that will come into stream.
Tupi field in Brazil, the first one of a series of fields in the shore of Brazil in a 600 miles trench.
Colombia, many medium size fields are being discovered there , Colombia is a stealth growing producer.
Mexico, yes believe it or not, Mexico is full of oil, problems is that Mexicans think that if they open their oil potential they will be invaded and absorbed by USA.
Cuba, yes, believe it or not, both in the south and the Gulf of Mexico "donuts" where Total, Repsol and others are actively working, Chavez is financing a big refinery in Cuba right now.
Canada, technology is improving Canadians capacities in mature fields and sand oil.
North Pole, where Canada, Russia and USA are running to make clear their rights.
Falkland Islands where extraction is difficult but possible
African coast (west) South of Guinea Equatorial to Niger
There is much bla..bla bla in OK,
It seems that Red sea has huge potential but Arabs are still very busy inland.

Problem is not if there is oil available, problem is if we should continue using it

Regards


On Nov 14 10:39 AM jerrydd wrote:

>
> To those who think oil production is going up, please tell me where
> it is going to come from and cover the present dying oil fields too?
>
>
> At about $120/bbl many alt fuels from NG, biofuels to Electric become
> not just viable, but far cheaper. And oil will be there by this time
> next yr.

Nov 14 05:27 PM

[Davewmart:]

Advill,
Extensive research has been done to produce figures which take account of new fields, as well as the decline rates of existing fields.
This is not a new thought to those who think that oil will become progressivly scarcer and more expensive, which now belatedly includes just about everyone who is academically involved in the field.
For instance, both the IEA report, and by extension the Uppsala report, since it bases itself on that part of the IEA's figures, are well aware and have accounted for the new fields.
The difference between the two reports relates to how fast they are likely to be developed, which for some strange and unexplained reason the IEA gives as being far faster than any prior experience.

In any case, the most cursory consideration of oil discovery and production data quite clearly shows that oil fields follow exactly the same mathematical laws as you would expect - the really large and accessible fields were developed some time ago, for the really massive ones in Saudi etc many decades ago, and on average new fields have become progressively smaller and more difficult and expensive to develop.
Some new fields are quite large, for instance the off-shore Brazilan one - but that is a good case in point, as it is stonkingly expensive to develop.

Nov 14 06:39 PM

[mbkelly75:]

An interesting article and discussion. From my own research, it would appear that there is plenty of oil still left, but it is harder and more expensive to get to. New technology has helped a lot and will continue to help. I love the quote from Rick Rule - it puts it as clearly and understandably as I have ever heard it done and I will pass that one around where it is appropriate. I am over-weight in Energy stocks for a reason. I think that the cost of energy will go back up and there is money to be made in good stocks in that area. In the meantime, the dividends are very nice and I am getting paid well to wait.

Nov 15 10:37 AM

[Sharon Merkle:]

Many have noticed. Apocalyptic ideation is itself a leading indicator of multi-sigma events. Keeping in mind that shell shocked trauma victims recover to function, but one city bus backfire and they dive under the coffee table, one can form a pretty good metaphor for market action like that of the last two months.


On Nov 14 09:41 AM Snitzer wrote:

> S/A's lunatic fringe quotient seems to be rising.

Nov 15 01:09 PM

[test213:]

Oil prices have been very volatile recently. In a way, the price action has been strange and has not confirmed the recent market uptrend nor the recent dollar decline.

Also, Fisrt Solar has not been moving higher like the rest of the market has done. May be the attempt to limit oil speculation has started working?

test213
admin at invetrics.com

Nov 16 07:22 AM

[chris coonan:]

With $100/b oil, there will certainly be a double dip.

Nov 17 07:40 AM