Jubak's Journal Recent articles: • 5 stocks for the continuing oil rally, 6/15/2005 • Why we were so wrong about 2005, 6/14/2005 • Why there is no housing bubble, 6/10/2005 More... | Jubak's Journal Higher oil prices? It's worse than you think Several factors will propel global oil prices skyward over the next three to five years. The silver lining? Investors have more time to make money on oil stocks. Here are 5 for the long term. By Jim Jubak The daily numbers from the oil markets are bad enough: On Monday, June 13, benchmark light sweet crude broke $55 a barrel on the New York Mercantile Exchange for the first time since April. But there's worse news for the economy and for any consumer who heats a house or drives a car: Under the surface, the news about long-term trends for oil prices looks even worse. For the next three to five years, the trend is toward higher prices with even greater peaks and valleys. If I'm right, however, it's still not too late to make a buck on the stocks of oil producers and drillers. In this column, I'll give you my five favorite picks for the long-term. (I gave my picks for the next six months in my column, "5 stocks for a continuing oil rally.") The long-term news on oil prices breaks down into three areas:
Falling production in the U.K., Mexico It's too early to say that the folks who predict that global oil production will peak in 2008 are correct. Following the theories of M. King Hubbert, a true iconoclast in the U.S. oil industry who in 1956 predicted that U.S. oil production would peak in 1970, the current generation of peak-oil theorists expect world production will start to decline as the rate at which new oil is discovered falls behind the depletion of proven oil reserves due to consumption. (For more on peak oil, see my column, "Is there fraud in the house of Saud?") But the peak-oil view has recently received big support from two oil-producing countries in widely separated parts of the world. First, recent government figures show that the United Kingdom, which has been a net exporter of energy for the last two decades thanks to the huge oil and gas deposits discovered in the North Sea about 35 years ago, has become a net importer of natural gas in 2005. A government report projects that the country will lose self-sufficiency in oil in 2009. By 2020, the United Kingdom will import about 75% of its energy. From its peak at the end of the 1990s, United Kingdom oil production has already fallen by about 30%. Second, a hemisphere away, Petroleos Mexicanos (PEMEX), the state-owned oil company that owns and produces all of Mexico's oil and natural gas, has warned that unless it can gain access to the latest technology for oil discovery and extraction, Mexico could become a net importer of oil within 10 years. Related news and commentary on MSN Money A good example of the problem is the huge Cantarell field in the Gulf of Mexico, which went into production in 1979. PEMEX says it will start to see oil production from this field, which now produces about 70% of Mexico's crude, start to decline from its current 2.1 million barrels a day sometime in the next few years. Outside experts say the decline is much closer at hand, and the most pessimistic predict a 20% drop production by 2010. The situations in the United Kingdom and Mexico are examples of the same problem, one predicted by peak-oil theories, but at different stages of development. Oil analysts estimate that the United Kingdom has pumped between 50% and 75% of the available oil and gas in its North Sea fields. The remaining oil and gas is in smaller and more-remote fields that are more difficult and expensive to exploit. Peak-oil theories predict that production from a field will peak and start to fall long before all the oil is extracted, since the more easily pumped oil deposits are extracted first. Mexico, in contrast, isn't anywhere near running out of oil and gas. Total crude oil reserves (proven, probable and possible) stood at 47 billion barrels at the end of 2004. Proven reserve total 17.6 billion barrels. (By contrast, Saudi Arabia holds the largest proven reserves at about 260 billion barrels.) But reserves are falling because potential new fields are much more difficult -- and expensive -- to find and exploit than Cantarell was. The company estimates that enough oil to keep reserves at current levels would require spending of at least $2 billion annually. But in April, the company announced that it would cut spending on exploration in 2005 by 25% to $1.5 billion. That might not seem like much of a decrease, but PEMEX funds its exploration and production projects with debt, and the company already carries $46 billion in debt on its balance sheet. And that $2 billion is just the exploration side of the required capital budget. Because any new fields will require more investment to bring into production, Mexican Energy Secretary Fernando Elizondo Barragan estimates that the company needs to spend a total of $15 billion annually on exploration and production. If not? Mexico becomes an importer of crude oil by 2016. It's not just the quantity of oil -- it's the location The long-term direction -- and especially the long-term volatility -- of oil prices doesn't just depend on how much oil the world produces but the relative stability of the countries doing the producing. For example, Nigeria, which is busy exploiting the rich potential of the oil and gas deposits in the Niger River delta, has said it plans to increase production by 10% or 250,000 barrels a day by the end of 2005. That added production would go a long way to making up for the expected decline in production from the North Sea fields this year. But oil from the North Sea is coming from a politically stable region where the greatest dangers are winter storms and strikes by oil-field workers. Nigeria's Niger delta region, on the other hand, has in recent years been ravaged by civil war. Oil workers are routinely kidnapped by rebel factions or local warlords out for a profit. Disputes between the central and state governments on who is to run oil production, refining and storage in the area have resulted in complete shutdowns of all oil activity. In the past, no oil company wanted to exploit potential oil-and-gas deposits in politically unstable regions like Africa because it was too dangerous and too uncertain. Producing oil from those areas now helps meet global demand. But it also means that the world faces a much greater potential for supply disruption than it once did. Any supply disruption, of course, produces a huge temporary upward swing in the price of oil. But while the price swings themselves may be temporary, rising volatility increases the risk premium that oil suppliers and traders build into the price of oil to compensate. Oil at $50 a barrel may not be worth finding Frankly, I find this possibility shocking. But some numbers in a recent Lehman Brothers report on oil exploration make a persuasive argument. Lehman Brothers looked at rising costs for exploration and production and concluded that many current drilling projects offered the potential for only marginal rates of return to oil companies. The culprit, Lehman Brothers said, wasn't higher costs alone but the combination of higher costs and lower-quality drilling opportunities. In other words, once a company had spent the money to find oil, there was a good likelihood that the oil deposit it found would be either too small or too expensive to earn the company an industry-average rate of return for its investment. One of the most interesting parts of the Lehman Brothers study is a finding that shows that gains to shareholders went down as exploration and development spending went up as a percentage of cash flow. The best-performing oil stocks were those who did relatively less spending on finding and developing new oil fields as a percentage of cash flow. The worst performers were, in general, the biggest spenders. Lehman Brothers concludes that a higher spending percentage in the current environment of high costs and low-quality drilling opportunities is evidence that the company is spending without sufficient financial discipline and on projects that should never have been funded. For investors, I think this adds up to a situation where oil prices are headed higher over the next three to five years, which would be the length of time that it would take for today's new production initiatives to show up in the supply of oil. But it's a situation in which the rising tide of oil prices doesn't lift all boats equally. For the long haul, I like these three oil stocks:
The first three stocks are already members of Jubak's Picks. I'd wait for the next dip in the oil sector to build positions in the two smaller caps. New developments on past columns Catch Pfizer while it's on the mend Pfizer Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak didn't own or control shares in any of the equities mentioned in this column. He doesn't own short positions in any stock mentioned in this column. | ||||||||||||||||
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