I Wish It Weren't True, But The World Badly Needs Iranian Oil

| About: Penn West (PWE)

It is interesting to see the specific oil price at which the general public starts to become concerned. Seven or eight years ago $50 oil was setting off alarm bells everywhere and raising concerns about a recession that would be induced by high oil prices. At that time $50 oil was uncharted waters. Today $50 oil which was a high price less than decade is a distant memory in the rearview mirror.

A few years later in 2008 we had the oil price spike to $150 and our perception of what a high oil price is was forever changed.

Over the past couple of years it has become apparent that an oil price under $100 now seems very reasonable to the American public. There have been very few headlines about high oil prices when oil ranged from $70 to $95. Recently even oil hovering around $100 per barrel created few headlines.

Today with oil creeping towards $110 per barrel we seem to have reached the edge of our comfort level as there are now lots of headlines about oil speculators pushing up prices and the two political parties criticizing each other's energy plan (or lack thereof).

And the price of oil is likely going to remain in the headlines, because from what my little brain can determine, the world has a real problem on its hands.

Please consider the quarterly global oil supply and consumption statistics from the International Energy Agency:

Global Daily Oil Demand - 2011

  • Q1 - 89 million barrels per day
  • Q2 - 88 million barrels per day
  • Q3 - 89.6 million barrels per day
  • Q4 - 89.5 million barrels per day

Global Daily Oil Supply - 2011

  • Q1 - 88.4 million barrels per day
  • Q2 - 87.5 million barrels per day
  • Q3 - 88.7 million barrels per day
  • Q4 - 89.0 million barrels per day

In the first quarter of 2011 the world consumed 600,000 more barrels per day than it produced. In the second quarter that figure was 500,000. In the third quarter 900,000 barrels per day and in the fourth quarter 500,000.

On average the world consumed 625,000 barrels more each and every day in 2011 than it produced. Global oil inventories therefore must have decreased by 625,000 x 365 = 228 million barrels.

You can still see that all year in 2011 we were eating into inventories in order to supply daily oil demand. And the problem is only going to get worse. The IEA is projecting daily oil demand to reach 91 million barrels per day in the second half of 2012. In the fourth quarter of 2011 global oil supply was only 89 million barrels. Where does the needed two million additional barrels of oil come from? With oil prices at $100 it isn't like anyone (except possibly Saudi Arabia) is choking back their oil production.

So that is where my thinking is on oil in the near term. My investments in oil producers however are of course based on the long term.

That makes an increase in oil prices pretty easy to understand.

The U.S. Energy Department basically confirmed these IEA numbers that I have been following this week.

Iranian Oil Coming Out of the Market?

Now in 2012 after a year in which demand outpaced supply by 600,000 barrels a day we may be facing a situation where Iran's 3.45 million barrels of oil are going to be taken out of the supply equation.

We have been dealing with oil at around $100 with Iranian supply included. What is going to happen if we suddenly lose another 3.45 million barrels per day? It sounds like a disaster scenario to me.

To put into perspective how big a losing Iranian oil supply would be, consider that last summer's release from the Strategic Petroleum Reserve involved 30 million barrels of oil. That would cover lost Iranian production for less than 10 days. The entire Strategic Petroleum Reserve could only cover lost Iranian production for half a year.

But what else are policy makers supposed to do with Iran and its quest for nuclear weapons? Which is worse, an all out conflict that kills thousands of people or a sanction induced oil shock that impacts billions.

I'd hate to have to make such a decision. My portfolio is loaded with North American light oil producers and I'm still concerned. Without losing Iranian production we have a rapidly tightening oil market. If we lose that production we could soon have a new definition of an oil price spike.

What To Do As An Investor ?

For me, the answer is pretty easy. Get a lot of exposure to barrels of oil in my portfolio. The daily supply demand numbers already support a high oil price. Iranian oil coming off the market makes a serious spike in oil prices seem likely.

If you are a fairly conservative investor one company you may want to consider is Penn West Energy (NYSE:PWE). Penn West has a dividend yield of over 5% and is just starting to attack its 6 million acres of land in Canada with modern horizontal drilling combined with hydraulic fracturing.

For a company of its size, Penn West is the most heavily weighted towards oil in North America. As the benefits of horizontal drilling start to impact production, I think investors are going to realize that this company has a lot of growth ahead of it.

Disclosure: I am long PWE.