Energy Bargains Ripe for the Plucking, Higher Oil Prices Dead Ahead
Commodities / Crude Oil Oct 29, 2010 - 08:03 AM GMTLadies and gentlemen, I’ll get right to the point: The future of the western world rests on your shoulders. Oil is the lifeblood of civilization, and we are dependent on foreign sources for oil more than ever before.
More than that, many of our foreign oil suppliers hate us. The four biggest reserves of oil in the world belong to Saudi Arabia, Venezuela, Iran and Iraq. If you were putting together a Facebook page for North America, none of those characters would friend us.
So, we need to develop our own supplies of oil here in North America and other friendly places. And we need to do it in a hurry. Oil has traded in a range between $70 and $85 a barrel for the past five months. My friends complain about getting pinched at the gas pump. I tell them, you know what, it won’t be long before you look at $75 oil as the good ol’ days.
This is the price of oil when the economy ISN’T firing on all cylinders. This is the price of oil when world oil production is in a small surplus, and stockpiles are at multi-year highs. Heck the U.S. dollar lost 8% of its value in a few months, and oil managed to stay below $85 — since oil is priced in dollars, that’s quite remarkable.
Some people haven’t noticed that the U.S. dollar is zigzagging its way lower. Believe me, the Saudis have noticed, and they’re understandably ticked off. The dollar rallied recently, but I don’t expect that to last.
So if this is the price of oil now, what will prices do when economic activity picks up and stockpiles dwindle? I’d say prices are going higher.
And this is actually a good year for supply. Both OPEC and non-OPEC production are higher. Sure, there are problems in Nigeria, and we saw the worst offshore oil spill in memory in the U.S. Gulf of Mexico. But the industry recovered from the Macondo spill nicely. And prices stayed in that comfortable range.
Higher Prices Dead Ahead
So let’s fast forward a year to October 2011. Where do you think oil prices will be a year from now? Well, we know that global demand is rising. Even if the economies of the developed world keep misfiring, the emerging markets aren’t waiting for us. The International Energy Agency (IEA) recently raised — again — its estimate of global oil demand this year to 86.9 million barrels a day. And the IEA expects global oil demand to increase 1.3 million barrels a day next year. That’s more than enough to eat up the surplus.
The big growth driver is China, though some other emerging markets aren’t far behind. To be sure, China’s thirst for energy goes beyond oil. Last year, China passed the United States as the world’s biggest energy user — a decade ahead of schedule. But today, we’ll concern ourselves with China’s oil demand.
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China’s oil consumption has doubled in the last decade, soaring to 8 million barrels a day last year. China’s oil imports increased 48% last year alone to 3.6 million barrels a day
China’s economic growth recently slowed down to 9.6% year over year. Any developed nation would kill for that growth. And the IEA says China’s oil demand is up 9.3% this year and should rise next year. Meanwhile, automobile sales in China are off the charts, rising more than 19% in September. And those auto sales are shifting into higher gear.
Steps taken by the government earlier this year to slow China’s economy haven’t had an impact on oil and fuel demand. The country’s crude imports climbed to a new record in September, passing the previous high set in June.
China’s M&A Frenzy
China is run by smart people, and they know they’re going to need more oil. That’s why China’s state-owned oil companies have become the biggest buyers in the global oil and gas M&A market. Last year, Chinese companies announced 11 acquisitions with a total value of $16 billion — 45% of total cross-border deals last year. This year’s tally isn’t in, but it’s going to be bigger.
Some important highlights of Chinese overseas oil and gas purchases include:
- CNOOC, China’s largest offshore oil producer, has made a joint-$5 billion bid for a Ghana oilfield containing about 1.8 billion barrels of oil.
- CNOOC has bought a $1 billion stake in Chesapeake Energy’s Eagle Ford shale oil and gas projects. CNOOC will pay an additional $1 billion in drilling costs.
- CNOOC is in talks with Nigeria to buy 6 billion barrels of oil — equivalent to one-sixth of the country’s total reserves.
- China has also made deals in Kazakhstan, Venezuela, Brazil and Canada.
China is also building a strategic oil reserve, which in the space of a few years has gone from nothing to a capacity of 281 million barrels. It’s going to get bigger. This strategic reserve has to be filled up with oil from somewhere. Every barrel they use is one we don’t get. And that makes the work done by North American exploration and production companies all the more urgent.
Falling U.S. Dollar Should Boost Oil Prices
U.S. oil and gasoline demand is fairly flat. The oil suppliers of the world can see the writing on the wall. They know that the future demand growth is in the emerging markets of China, India and beyond. In fact, the Chinese now import more oil from Saudi Arabia than we do. So the leverage we’ve had with OPEC — like the fact that they price oil in U.S. dollars, helping the dollar retain its status as the world’s reserve currency — is fast disappearing.
If and when OPEC moves to price oil in a basket of currencies, rather than just the dollar, that will be a major blow to the greenback’s prestige. But considering that the clowns in Washington print money like toilet paper, we shouldn’t be surprised if the oil producers of the world get sick of being paid in that same paper. In fact, an OPEC official recently said some members of the group are calling for a $100-a-barrel oil price, due to the dollar’s weakening.
I don’t think OPEC’s shift out of the dollar is coming soon — but it is coming. And it will shake the developed world to its very bones.
Then there’s the Federal Reserve’s next round of quantitative easing. Goldman Sachs says the renewed easing may total more than $1 trillion. What do you think that will do to the value of the U.S. dollar? If the dollar goes lower, oil is likely to go higher.
More Bullish News for Oil Prices
There are other indicators that are bullish for oil prices. The discount on heavy Canadian oil narrowed to the smallest margin in three months. Oil and gasoline stockpiles are going down. Supply from deepwater drilling in the Gulf of Mexico is going to start to fade. The fundamentals for the next move higher in prices are falling into place.
When I speak to traders, they point out some things:
First, that gasoline didn’t enjoy its regular seasonal rally this year.
Second, we’re seeing sideways action in the oil market because demand is low. This is building support. When demand increases — and it likely will — we could see prices surge fairly quickly.
And there is no risk premium in crude oil and especially natural gas. As one trader said to me: “Do you believe the world is more or less scary than it was five years ago? The risk premium will be coming back.”
Finally, oil traders can see that U.S. government policy is to manage the U.S. dollar downward. The paper money in your pocket is going to lose value. If that’s the case, wouldn’t you rather use it to buy hard assets … like gold, silver or oil.
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Looking across the industry, I’m very bullish. For one thing, the financial crisis that was so hard on small E&P stocks has passed, and as long as the Fed is keeping the money floodgates open, there will be plenty of financing for small companies.
And then there are the facts on the ground. U.S. rig counts are rising, with the number of oil and natural gas rigs hitting a 21-month high. Big foreign partners like CNOOC and Statoil are pouring money and expertise into shale oil and oil sands plays across North America. Momentum is gathering in the oil and gas fields of North America. And we need every bit of oil you can find.
We can’t count on foreign suppliers. Iraq just rejected two foreign gas firms that won an auction to develop fields in that country. Kuwait has cut its heavy oil target by more than half. Even old reliable partners like Mexico are seeing oil production start to decline.
It’s the oil and gas fields of North America that hold the promise of energy security. From the new frontier of the Arctic Circle to the oil sands of the Athabasca Basin to the Eagle Ford Shale to the brownfields of Texas and Oklahoma, and all points in-between.
I think the Independent Oil & Gas stocks are the key to America’s energy future. You may remember that the last energy emergency, between 1977 and 1981, came in two waves. At the beginning of that crisis, U.S. dependence on foreign sources of energy reached an all-time high — 47%. And the end of the second wave scared us enough that we were able to lower our dependence on foreign oil to just 27% by 1985.
Today, more than half the oil we depend on — 57% — comes from foreign sources! The need for domestic oil and gas has never been greater. Independent E&P companies hold the key to reducing that dangerous ratio, and it seems likely to me the shareholders of select companies will be rewarded when the next crisis hits, and there is always another crisis.
Jewels for the Taking
Sure, the natural gas market is still hitting the snooze button. There is an over-supply of gas in North America. But natural gas prices can’t scrape the bottom forever. We’re already seeing some drillers move rigs away from drilling for natural gas and toward drilling for oil.
What’s more, one thing that is depressing prices of natural gas in the United States is our imports of liquefied natural gas. But China’s use of natural gas is ramping up so quickly — surging 66% this year alone — that its LNG imports are expected to more than quadruple in the six years through 2015. That’s a very bullish force longer-term for both natural gas and natural gas drillers and producers.
Indeed, if you’re a value investor with an eye on the long-term, some real jewels are there for the taking. There are many bargains represented by people sitting right here in this room.
Again, the future rests on your shoulders. Let me make this clear: Most Americans live in a bubble. They’ve enjoyed cheap energy for decades. But we are in a global competition for oil, and the other guys have their running shoes on while the U.S. government is looking for its socks.
The small-cap exploration and production companies of North America are doing important work, and what you accomplish in the next few years may define America’s energy security for decades to come.
So, is there real value here? Yes! Will prices go higher? I believe so — yes! And what does that make these stocks? Bargains ripe for the plucking.
Thanks for your time.
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