Investing In Oil
Investing in Oil: The Days Of Cheap Oil Are Over
A Garry Writes Oil Sector Strategy Report
By Garry White
First Published: 4th April 2007
Pollyanna is a classic children’s book penned in 1913.
The eponymous young girl in the story transformed her aunt’s village with “gladness”. Quite simply, she always tried to look for the thing to be happy about in any situation; she dismissed the uncomfortable and donned rose-tinted specs. She filled the air with joy wherever she went.
It makes me want to vomit...
However, Pollyanna’s gladness was eventually tested when she lost both legs in an accident – so even she had to deal with reality in the end. That’s life, Polly…
We all need to have a grounding in reality – and I believe that it is important to live in the real world if you are serious about investing. That does not mean going with the flow or looking at the bright side of every situation. It’s all about facts. The truth, if you like. The reality is that the world faces a growing energy crisis which we will ignore at our peril.
Analysts have been a bit like Pollyanna when it comes to the oil price for years. They’ve been looking for the positives and ignoring the negatives. Most analysts were surprised when the oil price shot up from $30 in January 2004 to more than $72 in April 2006. They shouldn’t have been.
Investing in Oil: Underforecasting The Oil Price
Cast your mind back to 2004...
At the time, I was working on an equities newswire at Standard & Poor’s, assimilating information for traders all across Europe. Most traders don’t want to think too much – usually because they can’t – so I would get into the office at 6:30am to write their morning notes which they could then recite to clients. It’s then that I first realised just how far from reality these Pollyanna analysts are.
When the oil price was at $50, oil-price targets were upgraded to $45, when crude futures hit $55 they added another couple of bucks to their targets. The Lehmans, JP Morgans and Deutsche Banks of the world got it all wrong, wrong, wrong. They were consistently underforecasting the oil price, which then fed into their models and the entire sector was undervalued.
Unsurprisingly, this was then followed by quarter after quarter of consensus-beating results from the oil sector, as earnings forecasts had been calculated using their own off-base assumptions. The global analyst community had their noses firmly in the pages of Pollyanna – but pompously refused to accept it.
Demand follows various peaks: heating oil in winter; then the summer driving season to contend with; then supplies could be hit by the hurricane season in the Gulf of Mexico.
Of course, forecasting weather is difficult and unprecise; no-one has a crystal ball. But in the US, a feeling is growing that the US Gulf hurricane season could be very serious this year.
Investing in Oil: Meet Mr Bastardi
One man who is famous for his hurricane predictions is the most unfortunately named meteorologist in the world; a certain Mr Joe Bastardi of AccuWeather. Bastardi has something of a reputation across the Atlantic and people listen. He examines historical weather patterns to draw his conclusions.
It is significant, however. The last severe hurricane season in 2005 sent Gulf of Mexico oil platforms adrift and BP’s massive Thunder Horse platform – the largest ever built - was damaged before it could pump a single barrel of oil.
Thunder Horse originally was slated to start producing up to 250,000 barrels a day in 2005. The hurricane damage in 2005 and failure of a manifold during testing last year pushed its start-up date out to 2008. This is the very REAL damage that weather can do. It costs money and boosts the oil price for a real reason. A fact, not a fear.
Whether these forecasters are right or not remains to be seen, but I believe oil is actually going to get more and more expensive to produce going forward. There is an elegantly explanation by Dr Marion King Hubbert, which I will explain in a moment, but I don’t want to give the impression that I am a 100% Peak Oil devotee. I just believe it is one factor that is going to combine with increasing demand to keep upward pressure on the oil price.
Investing in Oil: Dr Hubbert and the Peak Oil Theory
Dr Hubbert was a geophysics professor at Columbia University and, while working for Shell in 1956, he made an unsettling discovery. Hubbert’s research found that oil fields change dramatically as you drain out the oil.
At first, barrels of crude come squirting out of the drill hole. That’s when times are easy. But after years of pumping, pressure disappears.
Suddenly, the rest of the oil gets harder and more expensive to draw out. And when you get to the halfway drainage point - the “peak” - the cost of getting the rest of the oil out skyrockets. Supply enters a permanent downward spiral. And pretty soon, you have to look somewhere else if you don’t want to run out of oil.
Hubbert predicted the US would hit Peak Oil production by the early 1970s. He was ridiculed and this research almost ruined his career.
Investing in Oil: But Hubbert was actually right
According to data calculated by the United States Department of Energy, the US hit its production peak in 1971 and US oil imports then tripled over the next few years. Take a look at the graph below. The chart was produced by the US Department of Energy in 2004 but, mysteriously, it can no longer be found on the government agency’s website. Providing perfect fodder for all you conspiracy theorists out there, no doubt …
What this graph tells us is that US Oil production peaked in 1971. Yes, that’s right – 26 years ago. Norway peaked in 2001… The UK in 1999… Syria’s oil production peaked in 1995…
Saudi Arabia’s Peak Oil date has been calculated as 2014. But we do not know if that is true. The Saudis are not exactly renowned for their open government, after all. The largest conventional oilfield in the world is the Ghawar. Every day, they have to pump 7 million gallons of seawater under the oil reservoir just to sustain pumping pressure.
This oil is not cheap. It takes energy and engineering to achieve this. In fact, this process has been going on for years - the first time Saudi Arabia started to inject water into their oilfields was 1956. Worldwide, peak discovery was in the 1960s.
Investing in Oil: The End Of Cheap Oil
There are many subscribers to the Peak Oil theory, but I do not believe it is the whole story. Technology is developing at a rapid rate and new techniques will be found to extract the last of the oil in current reservoirs. I am not saying that there is an equivalent of a Moore’s Law for oil extraction, but it is an argument against the view that the Peak Oil theory is going to lead to a $150 oil price imminently. But I do not believe that a cheap $30 barrel of oil is likely to be seen again either. Never.
For the past several decades, the world – and in particular America - benefited from a steady stream of cheap oil. This is coming to an end. America burns through 20 million barrels of oil a day…and that number shows no sign of slowing down, despite President Bush’s stated aim of reducing US oil consumption over the next ten years.
Regards,
Garry White
for Garry Writes
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