Today I watched a clip on CNBC where a representative from British Bank HSBC warned that the world has roughly 50 years of oil left. I don’t know about you, but given that all of our economies and the ability to feed the world is completely dependent on an abundant source of oil I thought that was a pretty concerning statement.
HSBC acknowledges that there are alternatives to oil on the horizon, but believes that we need to see at least $150 before any of them would start to become a viable alternative.
HSBC also did some analysis of the growth in emerging markets over the next four decades out to 2050 and they believe that the emerging market growth will put another 1 billion cars onto the road by then. That is on top of the 700 million that currently are driven globally.
Think about that for a second: 700 million cars today and we are going to ADD more than that in the coming decades. This is why I think investing in oil or oil related stocks is almost a no-brainer. The demand growth is indisputable.
And the fact that the supply side has pretty much peaked is almost indisputable as well.
Don’t take it from me. Take it from the International Energy Agency. For the better part of a decade the IEA has been downplaying the dangers of peak oil. This year in their annual review even the IEA said that it appears that conventional oil production peaked in 2006.
Even if we can increase oil production from current levels that production is going to be very expensive as it is going to come from oil sands, ultra-deepwater or other unconventional sources that are only economic at high oil prices.
I aim to profit from high oil prices, not suffer from them. One company I have been considering for several months is Penn West Energy (PWE).
Penn West is the leading producer of light oil in Canada. It pays an attractive 4% dividend at current share prices and with an enterprise value of around $15 billion seems pretty fully valued on existing reserves.
But I’m not interested in Penn West of 2011. I’m interested in the Penn West of 2015 and 2020 because I think it is going to be a very, very different company.
Penn West sits on an enormous amount of acreage and has producing oil conventionally for decades. And Penn West’s existing production and reserve bookings are based on that same old conventional production game plan.
But the game plan has changed. And the new game plan is going to bring production and reserve increases.
Over the past 10 years while Penn West kept plodding along conventionally producing oil, aggressive independent oil companies in Canada and the United States have been making technological advancements that have unlocked previously uneconomic oil resources. And while Penn West didn’t pioneer these technological advancements their huge locked up land position are going to make them huge beneficiaries of it. Because with all of their land, they are sitting on a ton of these previously marginal resources and they acquired them for next to nothing ages ago.
Penn West offers by far the most leverage to the move to unconventional oil production through horizontal drilling in Canada. A perfect example is the Cardium play in Alberta. As other companies paid hundreds of millions of dollars trying to lock up acreage in the Cardium in 2010, Penn West was already in the position of being the largest land holder (by far in the play).
It wasn’t because Penn West was the first mover who spotted this new play. It was because they locked up the acreage decades ago when the play was produced as a less economic conventional oil development. Now imagine how much more profitable the unconventional production will be for Penn West on a play that they paid next to nothing to acquire in comparison with other companies paying $10,000 plus per acre.
And this is an investing philosophy that I’m gravitating to. Find the companies sitting on the most resource. Buy them if they are reasonably valued based on existing production and reserves. And then sit back, relax and enjoy the next decade as they find ways to increase the amount of oil they can recover from 15% to 30% which creates production growth and reserve growth.
The existing production and reserves provides downside protection for the current valuation. The technological advancements and increasing oil price provides the upside.
The next decade won’t be smooth as oil is going to fluctuate on its journey higher and provide for a bumpy ride. But I think the end result will be rewarding for those who get long and stay long the oil sector and particularly Penn West. I don’t currently own any PWE, I’m waiting for a bit of a pullback to load up.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.