For several months now my portfolio has been loaded with companies that have large amounts of oil reserves and resources that will be produced in the coming decade. One look at where my portfolio was six months ago in relation to today can only signal one thing, that oil prices have plummeted. Because plummet is what my portfolio has done.
In fact my portfolio has dropped so far these companies must be losing money producing oil today. And what is the price of oil that has resulted in this drubbing for oil stocks? Is it $30? Maybe $40?
What, oil is $80? What is the problem?
So what is Mr. Market trying to tell me by pricing these oil companies so pessimistically? Is it that $80 is unsustainably high? Are we looking at a $50 oil world in the future?
I obviously don’t think so. And I’m starting to be surprised by how many oil industry executives are willing to say the same thing publicly. Because it may not be in their best interests to convince the world that high oil prices are here to stay.
Last week I wrote about the Peak Oil warning that Hess Company (HES) CEO John Hess has been delivering publicly. This week Shell (RDS.A) CEO Peter Voser made similar comments warning that over time oil supply and demand fundamentals are going to tighten significantly.
I would like to emphasize one specific comment that Voser made because I think it is incredibly simple, yet completely ignored by the mainstream media:
This is simple mathematics folks. The sheer scale of what has to be done is overwhelming.“Oil output from fields in production declines by 5 per cent a year as reserves are depleted, so the world needed to add the equivalent of four Saudi Arabias or 10 North Seas over the next 10 years just to keep supply level, even before much of an increase in demand.”
Take notice of the fact that Voser explains that four Saudi Arabias need to be added over the next ten years just to hold production flat. We need more than that to try to provide enough daily oil production to supply the increase in demand that is coming from China, India, and the rest of the emerging world.
Sit and actually think how gigantic the task is of trying to bring on four new Saudi Arabias. And we need to do that just to tread water on existing oil production.
The production decline rates on already producing fields and the lack of giant new discoveries are the problem. We used to be able to offset the declines and grow production because we were working from a smaller production base and because we had larger projects to bring on line. We also had a sizable buffer in the form of spare capacity in Saudi Arabia that we could count on.
Now we have a large daily production base that creates a larger decline to offset and we stopped finding large new oil fields forty years ago. Our spare capacity has been eroded and those decline rates and lack of large new discoveries are about to catch up with us.
We aren’t running out of oil. We just can’t bring enough smaller production projects on stream fast enough to more than offset what we are losing every year. It isn’t a tinfoil hat wearing conspiracy theory. It is grade three math.
All of this makes me very bullish on oil and companies. What makes me even more bullish is that not only do we have a scenario of supply and demand getting very tight, but virtually all new sources of oil are much more expensive to produce.
If oil prices drop, Deepwater or Oil Sands projects become uneconomic. That further puts a floor under long-term oil prices.
There is however one bright spot emerging that is going to help at least slow the onset of a Peak Oil crisis. And that is rapidly growing production from unconventional resource plays in North America.
Last decade higher oil prices motivated oil companies to figure out a way to unlock oil that has long been known to be trapped inside of shale rock. Horizontal drilling and multi-stage fracturing have been the key.
The stock market has started to pay attention to some of the better known oil (liquids) plays like the Bakken and now the Eagle Ford. But what I’ve noticed is that until there is significant oil flowing from the ground the stock market is not interested in any new play that the industry is opening up. I think there is big money to be made getting into companies that hold these new plays early.
I’ve got my eye several of these plays in Canada, and the United States, and have put together a portfolio of companies.
The formula I’m using is buy a stock that is valued by the market only for its known reserves, and get hundreds of millions of dollars of undeveloped acreage and future production value for free.
No company fits my formula better than Petrobakken (PBKEF.PK). Petrobakken trades at a discount to the present value of its known reserves. On top of that investors get for free Petrobakken’s undeveloped acreage in these emerging resource plays:
- Cardium
- Swan Hills
- Duvernay
- Montney
- Nordegg
Petrobakken’s drilling success ratio on the undeveloped land last year was 99%. In 2011, it has been 100%. This undeveloped land is not exploration work. It is development work. The stock market is making a big mistake in assigning no value to it.
Petrobakken has not grown production over the past year mainly due to the 1 in 300 year flooding that occurred in the Canadian prairies. Until production starts growing I think Mr. Market is going to price this company at a discount.
I believe that growth is coming in the next 4 months as there is nothing stopping the company from bringing 20 wells per month in production. August production was 39,000 barrels per day. In early September production was 41,000 barrels per day. By year end it should be 46,000 to 49,000 barrels per day. I hope that gets the stock market’s attention.
Don’t be a victim of the coming decade of high oil prices, profit from it.
Disclosure: I am long PBKEF.PK.
