Want to Profit from Sky-High Oil? Avoid the Majors

Crude oil prices are through the roof today. The black go rose more than $5 on renewed worries that Israel is about to whack Iran’s nuclear facilities.

According to a report in The Jerusalem Post:

Israel Air Force [IAF] war planes are practicing in Iraqi airspace and land on US airbases in the country as a preparation for a potential strike on Iran.

High oil prices are here to stay, says John Herring in Investor’s Daily Edge. But stay clear of oil majors if you want to profit. The best way to play the situation is the oil service sector…

But don’t expect oil to stay down for long. High prices are here to stay, and I believe we’ve seen the last of double digit oil prices. I could write a book about why this is the case (and many already have). But let me sum it up in three words.

Supply and demand. Currently, the world uses 87 million barrels of oil per day. But we only produce 85 million. The two million barrel per day shortfall comes out of existing inventories. And those inventories are rapidly falling.

The International Energy Agency [IEA] estimates that world demand for oil will be 100 million barrels per day in 2015. That is an additional 13 million barrels of daily production, expected just over six years from today. Let me put that in perspective. That is almost twice the daily production of Saudi Arabia!

In November of last year, Jim Mulva, CEO of ConocoPhillips (COP), addressed this point. He said, “Personally, I don’t think we’re going to see the supply go over 100 million barrels a day. Where is it all going to come from?”

Good question. While profits might be rising due to price, production is falling at almost all the major oil companies. Last year, ExxonMobil’s (XOM) production fell 10%… Shell (RDS.A) was down 6%… BP (BP) produced 2% less than the year before. And not only is production falling, but so are their reserves.

Among the largest international oil companies, not one of these companies replenished the oil they produced and sold last year. This might give you a hint as to why the major oil company stocks have not enjoyed “major” gains on the recent 100% increase in the price of crude.

Take a look at the chart below, comparing the price appreciation of crude oil to the stock prices of Exxon, Shell and BP:

The stock market is a forward discounting mechanism. No matter how profitable a company is today, if revenues are expected to shrink in the future, so will stock prices. And that is what is happening to the major oil companies.

Imagine a retail store that is extremely profitable. Now imagine every year, that store replaces only 90% of the inventory it sold. It doesn’t take a mathematician to determine that store will be out of business in a few short years. They’ll have nothing left to sell.

The same thing will happen to an oil company that doesn’t replace its reserves. For every barrel a company pumps and sells, there is one less barrel to sell next year. An oil company that does not constantly grow and expand its reserves is marked for death.

The major oil companies have no choice but to ramp up exploration and production. And they will spend TRILLIONS in their quest. The International Energy Agency [IEA] in its World Energy Outlook Report estimates that nearly $10 trillion will be spent on oil and gas exploration in the next 20 years.

I know a “billion dollars” might have lost its meaning in today’s inflationary economy, but a TRILLION dollars is still a hell of lot of money. $10 trillion is nearly unimaginable.

If you want your portfolio to ride this tidal wave of cash, don’t invest in the major oil companies. Their production numbers are falling. They’re already too big to make you huge profits. And most importantly, the oil companies are on the SPENDING end of all this capital.

You want to invest in the companies on the RECEIVING end of this cash… the companies that will help the petro-giants find and produce more oil. That means placing your long-term investments in the drillers and oil services. These companies are going to be swimming in cash for a long time to come.

Source: Is Big Oil Running on Fumes?

Comments

[redbaron]

I agree on the majors, and would add that the oil the the majors can't find, they will be forced to buy and acquire. The little guys who have the oil are going to be bought up by the majors, IMHO. Look for the independents with lots of reserves to be likely candidates.

[Lil-abner]

redbaron... I fully agree with your theory!

I am currently hold shares in a exploration company called Oilsands Quest(BQI).. They have discovered a large pool of reserves in N.W. Sask. Known as Axe lake! I can't help but to remain excited while this unfolds.

[oil baron]

Exxon alone has 275 billion in treasury stock and cash and can probably acquire most if not all of the second tier independents.
Redbaron is on target with majors reserves heading south sooner or later (I think sooner) they will come a calling for names such as chk,dvn,apa,hk to name a few.
It is much more important for these majors to book reserves whether through the drill bit or by acquisition than what they pay for these reserves. When was the last time we heard of a major's large discovery other that Chevron? 5yrs ago, 10yrs ago?

[fireball]

LIL ABNER so do i. i intend to increase if and when it seems prudent. i share your excitement. from what i have been reading it appears the majors are selling off a lot of assets. how would you interpret that. also marathon seems spread across the business. does anyone see them as a good buy? i guess they would be considered second tier?

[Stockaccumulator]

The only sort of "major" to profit big from is Petrobras (PBR)... ready to make one of its amazing leaps up 35% or so into earnings late July - august... PBR is not really a "major" but now larger than Microsoft in many categories, market cap, revenue, exponential profit growth... PBR always goes down 18% or so, then back up 35% or so into an just after earnings...

...so to feel good about being in a large Oil company, yet have tremendous exponential profit growth and share price rise, PBR is the only one to own... it will start its usual rise into earnings in the next week or two, then as analysts are recently predicting, it will rise to around $95 per share... we PBR longs have seen this over and over again... the same "controversial&qu... issues have been around since PBR was selling for $18 per share... the controversies about Brazilian gov ownership if much of PBR shares is not news, it is like owning a piece of Saudi oil/gov oil, no difference... a nice thing to be a part of in the future... true news on PBR is really fantastic, Barrons last week had it on the cover page, and restated that it is a must own for oil, especially during this "'opportunity pullback. Read Barrons on this... best to all of you...

[Khunoye]

Oil?.....yes! Natural Gas, however, is missing from your equation. As a geologist for one of the majors, I can assure you there are significant volumes of US domestic natural gas yet to be discovered in under explored deep basins and under developed fields. 3D Seismic and other technologies make these low risk, high yield targets very economic at today's prices. For onshore natural gas, we can find it and flow it to market in a 1 to 5 years. It is just a matter of converting our mode of transportation and energy use from gasoline/diesel to methane.

[Popska5125]

Marathon is not going anywhere pricewise. Too much refining cost to make any good numbers. Perception of the company is that it is a refiner and retailer. Neither make good stock price advancements.

[DonaldRay]

Could a lot of the oi majors having less production be from getting kick out of some countries off shore oil field..not too mention some inlard fields..Russia comes too mind.

[Bobco23]

All valid and interesting comments. APC, APA, etc. all look to be brides sometime in the near future. Oil service and exploration stocks look equally attractive. There is one paradigm changer that was not discussed - what happens if congress changes the drilling rules and opens up vast areas of the US for E&P? The majors seem the likely candidates to win these leases. Given the broohaha over Boeing/Airbus tanker contract, I can't see any leases going to foreign majors. So the question is, could the US majors see new life from voter pressure on congress to DO SOMETHING.