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A Note of Caution for Oil Bulls

Jan. 19, 2011 9:00 PM ETXOM, EQNR
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A Note of Caution for Oil Bulls


For the record, I am, and have been, for quite some time, bullish on oil. Despite that, I’m starting to read things that indicate that some of the bloom may well come off of the rose, over the intermediate, and longer term. Please note that qualifier; I’m most emphatically NOT suggesting any sort of sharp correction in oil prices is in the offing, barring another global financial melt-down.


The first item is the increasing rate of development of “alternative” oil/gas. While initially, there was some doubt as to how sustainable the early production rates from shale field wells might be (notably with NG), in the case of oil, at least, this fear might be overblown. A recent article in the Calgary Herald, written by chief energy economist and Managing Director at ARC Financial, Peter Tertzakian, noted that horizontal drilling and hydraulic fracturing of tight oil reservoirs has been successful in at least slowing the rate of production decline in North America. He writes:


“For example, in North Dakota’s Bakken play, oil production has risen from zero to 250,000 B/d in a few short years. The Bakken can be viewed as a proof-of-concept oil play much as the Barnett was to natural gas. Horizontal drilling targeting oil is extremely profitable at current price levels and so will continue to climb through 2011. As such, oil production from nascent plays in both the US and Canada is rising quickly. This year’s North American oil production growth is going to confirm the reversal of a 35-year decline and maybe even shake a few peak oil theorists.”


Additionally, such tight oil and gas formations seem to be fairly widespread globally, from China to Europe (Poland is notable, in that regard). There’s little doubt that the technology to tap such fields is spreading quickly.


Again, looking out a few years, it seems only a case of “when”, rather than “if” meaningful production increases will be seen coming from Iraq, in particular, from the northern region under Kurdish control.


The next thing I’m looking at is “green” energy (wind, solar, geothermal, hydro, etc.). I still think that meaningful progress, in terms of increasing the percentage of energy needs that such technologies can satisfy, is still far in the future, I’m seeing a caveat, in the terms of the Chinese push in this area. I sincerely doubt that China’s engineers and scientists are that much smarter than those in the West, if at all, but the Chinese trump card is their “central command and control” economy. Unlike the West, where two steps forward are followed by one step back, as various factions bicker and snipe, once the Chinese government decides on a course of action, for better or worse, its “Katy, bar the door”.


Since so much of the current strength in oil prices has been laid at the feet of the emerging markets generally, and China, in particular, I feel that this is something that oil bulls need to keep a close eye on.


Now, let’s look at the above, and try to see how this might impact investing decisions, over the intermediate and long term.


First, it seems obvious that oil companies, particularly the purer E&P plays will be pressured by any sort of throttling back in oil prices, or even in the rate of price increases. The international giants, such as XOM, should weather any storms fairly well, as they have the capital, as well as the technological skills, to enter into other areas of energy production, not directly connected to the production of oil. Two examples are XOM’s moves into the biofuel area, and STO’s use of the expertise in operating/maintaining offshore oil platforms in the development/maintenance of offshore wind farms.


Another area that may well come under pressure is the tanker industry. To the best of my knowledge, just about all of the alternative oil/gas plays are on shore, meaning that as these are developed, there will be less need for tankers to transport oil from place to place. By the same token, companies that own land-based pipelines, storage and processing facilities should benefit, since the products produced must still be transported from the fields to the refineries. As an aside, I’m starting to think that the LNG shipping industry might end up being the answer to a question that people have stopped asking, given the widespread geographic availability of shale gas.

Source: Calgary Herald

Disclosure: Long STO, PVX, KMR, MMP, DHT, TNK, TOO

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