RE: A bottom???Energy prospects brightest when the news is bleakest
FABRICE TAYLOR
April 8, 2009
The short version of the energy investment thesis is "buy it." The long version is "buy lots of it."
Theworld burns about 85 million barrels of oil a day. We spill almost asmuch ink breathlessly debating the price of it and where it's going.But the story is pretty simple: Depletion is relentless, "high-grading"is at a fever pitch, investment is bare bones and demand is only goingup over time. Prices will follow faithfully, until we run out, by whichtime we'll either be dragging our knuckles on the ground again or we'llhave found another way to fuel modern life and SUVs.
In the meantime, the mantra is that low prices cure themselves. It'snot a coincidence that oil hit a long-time low of about $11 a barrel in1998 and then roared for a decade. No one wants to look for oil whenthe cost of selling a barrel doesn't cover the cost of finding andproducing one, so they don't. Reserves don't keep up and prices go backto where the economics make sense.
History doesn't repeat, but it rhymes. Production from big existingfields around the world is falling by almost 7 per cent a year, saysthe International Energy Agency.
The rate of decline, more importantly, is accelerating.
That obviously cries out for development, but at 50 bucks a barrel, it's not happening, or at least not enough.
On the contrary, projects are being mothballed, especially marginalones like oil sands. Total SA, which is supposed to be keenlyinterested in UTS's share of Fort Hills, is at the same timecontemplating postponing another big oil sands project because of costsand technical issues.
Meantime, the best assets - the ones with the lowest costs - arebeing exploited, much like miners "high-grade" their deposits bydigging up the juiciest ore when times are tough to stay profitable.
Think about that decline rate: In the absence of development, oilprices will spike because demand isn't falling as much despite therecession. And longer term, demand will rise, even if the West'sappetite for oil has, as some insist, peaked. There are three billionpeople in the developing world consuming a fraction of what we do butclamouring for more.
The math is inescapable: Demand is going up.
So we need to find more oil but we won't look hard for it at theseprices. What price then? It could be a lot higher. Non-OPEC productionactually fell from 2004 to 2008 even as prices surged. A big part ofnon-OPEC production is in the developed world. Don't we have all themoney and technology? Yes, but we want better returns than $100 oiloffers. So OPEC's influence is only rising. And what do the sheikswant? A "fair" price of $75 a barrel.
Oil shares, meanwhile, don't reflect that kind of price. If you buythis scenario, oil equities are cheap. Junior concerns especially so,and particularly if they have sound balance sheets. To put it in adifferent context, the global reserve replacement cost is about $20 abarrel. The last numbers I saw pegged the market value of juniorproducers at less than $15 - and they have upside in theory. Oil ischeaper on the stock market than in the field.
The story for natural gas is similar but the horizon is a littlefarther out. Shale and tight gas are uber-abundant, but even thesereserves deplete fast. Other than liquid natural gas they're the onlyU.S. sources that are growing but a back-of-the-envelope consensus ofcredible forecasters implies they'll peak within three or four yearsand everything we're saying about oil will apply to gas.
There's not a lot of good news flowing out of the oil patch, butit's when the news is bleakest that the opportunity is brightest. Mostinvestors miss it. If this thesis makes sense to you, try not to missthis one.
Fabrice Taylor is a chartered financial analyst. ftaylor@globeandmail.com