The Truth is Out There.

An e-mail that is attributed to Matthew Simmons, posted to a yahoo newsgroup:

Dear Dr. Scott:

Thanks for your excellent set of questions. I will try and shed some light on what I now think I know about Middle East Oil. When you quote me saying that Saudi Arabia has 260 billion barrels of proven reserves, totaling 25% of global production, which lasts 90 years if you take their straight line production today and assume it stays level until "the cupboard is bare"...these are their official numbers and the general mantra folks use to then ignore the prospect that we might now be approaching peak oil.

Until two years ago, I assumed these numbers were probably true as I had heard them so many times from so many experts. A single six day trip to Saudi Arabia set off various questions I had as to whether these "facts" were really facts or simply opinions or educated guesses. This led me into the most intense research I have ever done and the effort resulted in my pending book, "Twilight In the Desert". John Wiley & Sons are publishing it and publication date is May 27th. The book will set out hundreds of pages of data on an astonishing story.

The myth that Middle East Oil is so abundant at such a low price that there is not even a need for more Middle East exploration was only a thesis. There were educated technicians at Chevron and the other Aramco owners as early as 1972 who were beginning to get concerned that if the handful of key oil fields in Saudi Arabia were produced at a 9 to 10 million b/d rate, these fields would go into irreversible decline by the early to mid 1990's.

By early 1979, as the old Aramco owners were packing their bags and Aramco was being taken over by Saudi's, the sense that these fields could produce even 12 million b/d without starting into a sharp decline in the early part of the 2000 decade was getting widespread among the real technical experts. Sadly, this knowledge was kept under wraps and the entire world began to assume that oil was so abundant that we had about 15 to 20 million b/d shut in supply as the price of oil collapsed in the mid 1980's.

We then spent two more decades in the comfortable illusion of cheap oil forever.

It was never true.

I hope the lengthy two years of work that went into my pending book will finally be a tipping point to begin educating energy planners that Peak Oil is here.

What all this means is also important for people to understand as it does not mean social chaos if everyone understands what the issues are.

I spent a great deal of time in my final chapter called Aftermath trying to spell out a series of things people need to begin thinking about to avoid the panic your questions implied. All this sounds like an advertisement for the book but I am hopeful it gets wide readership as its message is of the utmost importance.

Feel free to use any or all of these comments to any others interested in the topic.

Best regards
Matt Simmons

Sea Change.

Mike Holland as guest host on CNBC Squawk Box today. He's been talking about XOM being a large holding for a while, so he's got a grip on the story.

His view: Any sell off/retreat in the oil stocks would be a gift, as you should take it as an opportunity to buy for the longer term. (Stocks he mentioned XOM, BR - note BR more of a natural gas play, but n.g. may have a big role eventually - and a couple of others I forgot.)

He is familiar with the work of Matthew Simmons, and he mentioned some of Matt's ideas: We've turned a corner, it may be a sea change, demand is very strong, it's now the supply story, Saudi Arabia appears unable to open the taps as widely as people had thought, as a result oil may no longer be a cyclical thing, "We don't have as much of the stuff as we thought." And prices may be well higher than we thought.

Infidels.

There's an article on MarketWatch.com which quotes a number of oil analysts as puzzled on the price of oil.

Clearly the oil stocks have gone vertical, with a year's worth of return in 2 months. So it's a dangerous time to buy, I think.

Jim Cramer on his radio show Friday spoke a lot about the oils, and his recommendation was to trade out of the more expensive ones into the cheaper ones. [Interesting, but not something I'm doing. I may just outright be selling some.]

Bob Brinker on his Moneytalk show ranted over the weekend on OPEC and how they are gouging us. He seems to use straight stocks (mutual funds), bonds and cash, so I'm not sure if we'll ever see an oil call from him. (But maybe we use his rants as a timing signal? Or that of his callers? They were mostly focused on general questions, with a lot of real estate.)

Welcome aboard to Prudential Equity Group, fashionably late as usual.

Richard Russell, a gold and stocks guy, talking about oil? A sign?

I noticed something else last week. Oppenheimer oil analyst Fadel Gheit, who throughout last year showed up on CNBC saying oil prices were "too high, didn't really belong there, and you shouldn't buy oil stocks as a result", now is saying "buy them now, because if you don't, they will be more expensive next year if you have to buy them then."

I always get very wary when I see someone finding religion like that. Last one in the pool is a rotten egg! But judging by the article mentioned at the top, we might have a ways to go.

Frighteningly profitable quote of the week:

"If you plugged in $50 oil and $7 gas into the numbers for exploration and production companies and the majors and carry that through to the service companies, you would end up with phenomenally large earnings," he said.

Under that scenario, oil and gas earnings would account for 20 to 25 percent of all S&P 500 earnings. Last year, they accounted for about 15 percent of the S&P 500 earnings.

The Top 10 Signs of Impending Hubbert's Peak.

What to look for to let you know we might be right at Hubbert's Peak:

10. Ashton Kucher buys himself an M1A2 Abrams tank.

9. Toyota Prius tops "Most Stolen Vehicle" lists nationwide.

8. Appearing at your local theater: Leonardo DiCaprio in "The Oil Man", a John D. Rockefeller biography.

7. Apple introduces an Ipod bicycle charger attachment.

6. CNN develops cool flying "Resource War" graphic and dramatic theme song.

5. BusinessWeek cover proclaims: "The Death of Oil."

4. Survivor: ANWR

3. Trump Oil

2. Operation Alberta Freedom

1. A video shows up on the Internet of Paris Hilton having sex with a gas station owner.

Canary in a coal mine.

New presentations from Matthew Simmons, something to read and ponder.

First, this one here, a solid look at the oil situation in terms of peak oil.

Secondly, one that is more focused on how we got here, and where we may have gone wrong with energy pricing, leading us to overproduce and overuse energy in the past.

We may have both wasted energy and gone down a path of globalization that might not make sense with high oil prices.

This is fascinating stuff folks, and though it's possible we may be early, I think this stuff is right on target.

[I have a thought on his second presentation - China is sucking in high cost resources to produce and sell items cheaply all over the world. There is already huge competition in China and profit margins are tumbling. Are they bankrupting themselves in this equation? What does that suggest about investing in China in an era of high resource prices?]

That 70's Show.

Joe Kerner on Squawk Box on a little rant today that the only thing working in the market is the oils. Everything else is just going nowhere, including his beloved GE.

Meanwhile, today's guest host Tom McManus of Banc of America Securities, gets it: Invest in the inflation hedges, eg. energy. He also likes insurance. Stay away from stocks hurt by rising rates: financials, REITS, utilities.

If there are parallels to the 70's here, which was also a time of rising inflation brought about by high oil prices, then the best performing assets may be:

Oil stocks of all kinds, gold and gold stocks, small cap stocks over large stocks.

If oil prices get out of hand, they will trigger a recession. Then you're best off in bonds, the safer the better.

If oil prices get really out of hand, they will trigger a depression. Then you're best off in government bonds (preferrably Norwegian - they have a decent amount of oil and relatively few mouths to feed- this reminds me - check if Pimco's overweight Norway, Canada in their bond funds) and cash.

Cramer on thestreet.com

The important takeaway is that these corrections are simply selloffs in a secular growth pattern, not the end of the cyclical ramp . We need to find more supply, switch to a better supply than fossil fuel or have a major recession to curb oil demand. I don't see any of those happening, which is why I wish we would get the darned correction started and over with: Oil's still the best thing going out there.

These stocks aren't going away. They are just going to recharge and fight their way to becoming the 10% of the S&P 500's market cap they deserve to be.

Shock therapy.

In the reporting of the interview with the Saudi oil minister that I've seen/heard today, everybody is focusing on the fact that he suggested the price of oil will be $40 to $50 this year based on demand. And the tone of the commentary is one of shock.

I think a lot of people could have told you that (i.e. people mentioned in prior posts).

What was a surprise to me was his suggestion that they lower the quality of the crude in the OPEC basket to make the price look lower, which isn't mentioned in the reporting.

Ah, what do I know..

Here's his quotes:

"The seven crudes that constitutes the OPEC basket are not really representative of the crudes that OPEC produces, and so there'll be two changes, probably. One, are the types of crudes in the band, and then of course, possibly a new band."

"Where the price is today, between $40 and $50, will probably be with us throughout 2005. I'm always reluctant to make a prediction as to where the price is. But just looking at fundamentals, inventories, supply, demand and the worldwide desire for a stable oil market; I believe it will be in this band."

OPEC Slight of Hand.

There are a wide variety of oils produced around the world, from the best - light, sweet, to the least desirable -heavy, sour. OPEC uses a blend/average of the ones they produce to determine what the average price of oil is.

The Saudi oil minister, interviewed on CNBC, suggested that OPEC will lower the quality of oil in it's basket as one way of lowering the price of oil.

Since the spread between the price of the best and least desirable types of oil has been unusually wide the past year, this could make for a significant drop. It's probably not a coincidence that the extra oil Saudi Arabia came up with last year was increasingly heavy, and that in general that's what is showing up on the market.

It seems he is suggesting that there's more of the cheap stuff to come. What does that mean for the price of light, sweet? Up, up and away. I can hear the Nigerians striking already..

P.S. I would say this slight of hand is totally outrageous, but in the meanwhile I'm eating from a cup of yogurt that used to be 8 ounces, but one day shrunk to 6 ounces and maintained the same price. And I suspect any day soon I'll open a small bag of chips and find only 1 chip inside.

They're shocked, SHOCKED to find oil prices rising!

I don't quite get the CNBC anchors. They're clearly intelligent people, they discuss and report on oil all the time, and they talk to world renowned oil experts regularly. Yet they still seem genuinely shocked to see oil prices going up. I'm not sure if it's a journalist need to remove themselves from the story, or maybe the McMansions in Bergen County and SUVs are coloring their views?

Anyway, today they interviewed Matthew Simmons. Here's a few quotes:

"I think we're basically now at the end game of this sort of battle that's been going on between the optimists and the realists about what really constitutes a fair price for oil. It's really interesting, if you go back to the summer of two years ago when oil prices were at $28 to $30, there was an enormous impression that that was a war premium, and then all of a sudden at $40, that's a fear premium, and then at $50, it's the hedge funds. And one of the things that's happening right now is demand is starting to outpace supply, and supplies are tight. So I think basically some of the realists are essentially saying maybe oil prices are actually where they should be, or maybe they're not as high as they need to be."

"We're in a tight market. Could oil go to $100? Sure it could. If demand exceeds supply, you introduce genuine scarcity and then there really isn't any sort of automatic level that prices level out."

"I think we basically ought to all observe the oil market, take a cold shower, and start watching very carefully real supply versus real demand; it could start pulling away from us - it being demand - in a pretty dramatic fashion."

Read between the lines.

South Korea announces it will diversify it's foreign currency holdings to include Canadian and Australian currencies. = South Korea is aware of peak oil and is putting money in the currencies of countries with large deposits of various natural resources including oil and natural gas. Notice they didn't put it in the Euro, the supposed new alternative to the dollar, because the Euro countries have almost no oil and gas left.

Morgan Stanley upping oil price forecast. = Standard Wall Street self dealing. First, Morgan Stanley made a deal to buy oil forward, now they announce the price of oil might be going higher. "The key reason for these forecast changes is that oil markets are today much tighter than we thought." Yes, that's also the key reason you locked up Anadarko's production, only you're telling us about it after you're already in.

Oil companies having trouble keep reserves up [$]. = Okay, maybe you don't need to read between the lines on this one. There's a little bit of a debate here (should the prices used to determine reserves with economic value be from Dec. 31 only, or an average over the past six months say), but the major point is the major point - oil companies are having more trouble maintaining reserves, let alone increasing them.

Meet Matt Simmons.

Mr. Simmons is an energy investment banker with his own firm in Houston, Simmons & Company International, and was one of the members of the infamous Cheney energy task force. He is also a believer in peak oil and has done a lot of study on the available data on Saudi Arabia's oil fields, which apparently left him a little queasy. [I am eagerly awaiting Matthew Simmon's new book "Twilight in the Desert", which covers his research and conclusions, see link in the sidebar.] In the meantime, check out the latest presentation [PDF format] he has available on his company's site. [There are older ones here, they are also very good.]

This is an interesting presentation, as it goes into details of investing in the energy sector. Among other thoughts, he points out something I have also noticed: A couple of big institutions have made big bets on energy.

The number 1 - Capital Research Management - appears near the top of every oil stock's holders list I check these days. If you aren't familiar with them, they run the huge American Funds mutual fund operation out of Los Angeles, CA. They are very low key versus the other two biggies, Fidelity and Vanguard, mainly because they have load funds and thus let the brokers do the selling for them. They run their funds with teams rather than individual managers, leading to less emphasis on 'stars', but they have generally very good to excellent performance records.

I feel less like a maverick now.

Blame Canada.

Let's not kid one another - converting oil sands/tar sands or oil shale to oil is something nobody wants to do.

Not only does it require a bigger upfront investment than land based oil drilling, it also pollutes more, creates more global warming gases, is less efficient (you have to burn natural gas in the process, or use some form of energy), is more disfiguring to the environment and in the end produces the least desirable type of oil - heavy, sour crude.

But we're going to be doing it and oil companies are investing billions in it, because the peak oil problem is real, and corporations are finally buying in.

There are 3 areas that have huge deposits - Canada, Venezuela, and the US. The US form is oil shale, which is actually even less desirable than tar sands/oil sands. But the US government and the US Navy deems it to be strategic enough that they keep an eye on it anyway. [I believe the US Navy is the world's largest single energy user.]

Companies that have some exposure to this business, with their US ticker symbols:

Suncor - SU - Canada
Canadian Oil Sands - COSWF - Canada
Encana - ECA - Canada
Canadian Natural Resources - CNQ - Canada
Imperial Oil - IMO -Canada - ExxonMobil surrogate/possible takeover candidate.
Shell Canada - SC and RD - Shell subsidiary.
Nexen - NXY - Canada E&P.
Husky Oil - sub. of Hutchinson Whampoa - HUWHF
ConocoPhilips - COP - Canada and Venezuela
Statoil - STO - Venezuela
PetroCanada - PCZ - Canada
Murphy - MUR - Canada

[Some of the above companies are involved in Syncrude, as these undertakings are so expensive, they needed to band together.]

There are probably a couple I forgot, but that covers the majors. Further reading on this topic here, here, investment ideas, and a little here. (Post original publish - new link here.)

[Disclaimer: I own ECA and CNQ right now, have dabbled in a few of the others and probably will again.]

Trust No One.

Mulder was right.

Except we aren't battling aliens hidden among us, we're watching as a high stakes global chess match unfolds over access to energy supplies. Because oil in the ground you can count on = money in the bank = a future for your country.

Ponder the following:

1.) The US has stepped in to 'liberate' first Kuwait, then Iraq, at the same time defending it's friends in Saudi Arabia, Qatar, U.A.E. (Forget what you read in the papers about Saudi Arabia, it's all bullshit. We scratch their backs, they scratch ours. The frictions you read about in the paper are play acting to keep the Muslim world pacified.) Oh, and that surprise deal with Libya? Let's just say that Occidental Petroleum and a few other US firms were really happy to hear about that. If you sit down and ponder this, you realize we just locked down as 'friendlies' a huge portion of the world's oil supplies. [When I say 'friendlies', I ain't saying they're going to sell to us cheap. But they'll sell to us, and they're not going to cut us off again, which at this point would be devastating.]

2.) The war on terrorism conveniently allows the US to park it's forces all around the globe: the Middle East, Africa, South America, the Caspian Sea area. Oh, and by the way, a lot of oil is nearby each one of those.

3.) China is increasingly scouring the globe for energy (in Venezuela, Canada, the Middle East, Africa, the South China sea) as it dawns on them that they are building a huge infrastructure for which they have neglected to ensure long term, reliable sources of energy. This will bring it into conflict with the US and Japan, maybe Canada and Europe.

4.) The Russians, recovering after their long and serious malaise, catch on to peak oil and defacto publicly behead one of their own major corporations (OAO Yukos) as a warning to other corporations and the world that they will do whatever it takes to retain control of their energy supplies. OAO Yukos was on the verge of a major deal with ExxonMobil, but this is now too valuable a resource to sell at current prices.

5) Iran works on developing nuclear power. Ever ask yourself why a country with rich oil and gas reserves needs nuclear power? Because oil and gas will be worth a lot more on the world's markets.

Chris Edmonds on oil prices.

An article from Chris Edmonds of thestreet.com suggesting that oil prices are likely to remain on the high side and concludes:

Here are the expensive facts: Demand for crude oil is growing, crude oil is becoming harder and more expensive to find, and there are few alternatives for the pervasive nature of energy in nearly every facet of our lives.

I'll take that - to go.

XOM passed GE in market cap today and oil/energy stocks in general have skyrocketed this year.

Jim Cramer made a call today on his radio show to take some money off the table here in energy stocks, and it sounds like a reasonable call. Though my general impression is that most people are underweighted in energy, these stocks are going straight up, and it is probably unsustainable.

Of course, I thought the same thing when I sold my Munder NetNet fund in 1998. Or was it 1997?

Party like it's 1899, er 1999.

XOM about to overtake GE as company with largest market cap?

Oil, natural gas, coal on the 52 week highs?!

IPO calendar with oil, natural gas, shippers and coal?!?

No end in sight.

Stephen Leeb on Bloomberg radio today explaining his current thinking on oil: Oil is in a strong, protracted uptrend with no end in sight. There will be pullbacks, but in 3 - 5 years he believes the price will be much higher. With the supply/demand imbalance, driven by increases in demand from India and China, there is little reason for this trend to moderate. When asked about the development of alternatives to oil, he said that until the many disbelievers change sides, there won't be a big push to alternatives.

I'm going to go out on a limb and say a few of those disbelievers threw in the towel today.

P.S. Stephen Leeb has a book, "The Oil Factor", he co-wrote with his wife explaining his investment ideas around oil, see link in sidebar.

He said / She said.

Were these people at the same conference?

The glass half full view from Oil and Gas Journal Online:

CERA: World oil production capacity may grow 16 million b/d by 2010
Sam Fletcher
Senior Writer
HOUSTON, Feb. 15 -- World oil production capacity could jump by more than 16 million b/d to 101.5 million b/d by 2010, with the addition split "fairly evenly" between members of the Organization of Petroleum Exporting Countries and non-OPEC producers, said an executive of Cambridge Energy Research Associates, a subsidiary of IHS Inc.
In a Feb. 15 briefing at the weeklong CERA executive conference in Houston, Peter Jackson, director of oil industry activity, said 7.6 million b/d of the projected increased total liquids production capacity would be from non-OPEC producers, with OPEC supplying 8.9 million b/d. World production of crude liquids is not expected to peak before 2020, he said.
"That is potentially what they can produce. Whether it actually gets to that point is another issue," Jackson told OGJ Online after his press briefing.
He said producers "obviously are trying to add more light, sweet crude to their stream." However, Jackson said unconventional oil supplies would increase to about 20% of the total potential supply during that same period, from about "16% or so" at present. "The crude stream composition also is evolving in proportions of light, medium, and heavy crude," said Jackson.
CERA's projection is based on a "field by field, country by country" examination of potential production capacity. According to that study, Jackson said, "Major deepwater projects worldwide should show a tremendously strong increase of about 6 million b/d, which is quite a large proportion of the 16 [million b/d] that I'm talking about." That additional production from water depths beyond 2,500 ft will be "from countries like the US in the Gulf of Mexico, Brazil, Angola, and Nigeria," he said.
Non-OPEC production capacity is expected to continue strong through 2010 but then "slow down somewhat from current levels of increase," Jackson said.
OPEC productionWithin OPEC, Jackson said, "The most significant changes are going to be found in countries like Nigeria, which could show an increase of just over 1 million b/d by 2010. And this is light, sweet crude, which is obviously very much sought after in the current market." Iran and Iraq also are expected to register major gains in production capacity, potentially up by 1 million b/d each, although "Iraq is a little more difficult to make judgments about because of the political situation," he said.
Among the 11 OPEC members, Jackson said, "Really only Indonesia seems to be struggling to expand capacity." However, he said, Indonesia has had some success in slowing its production decline rate.
Among non-OPEC countries, the best prospect for increasing production capacity is in the Caspian region, which could be up by 2.5 million b/d by 2010, Jackson said. He foresees "other significant increases" in Russia and Canada.
"We do see flat to declining capacities in countries like Norway, the UK, and Mexico. We get very pessimistic about the rates of declines in these countries, but with the application of new technology [and] better understanding of the hydrocarbon systems in these areas," he said, the production decline rates might be slowed.
Another CERA analyst noted the "strongest price environment ever" in 2004 because of strong demand, primarily in Asia. World demand growth was up by 2.5 million b/d over the previous year. If demand growth continues at that blistering pace in 2005, he said, "then yes, we will have another year of very strong oil prices. If it were to continue beyond 2005, then there would be challenges in bringing on [additional production] capacity in a timely manner."
A cautionHowever, the analyst said, "Let's be very cautious about saying that we've entered a definitive new era of exceptional demand growth. The reason demand grew so fast last year was because the global economy expanded at the fastest rate since the 1970s."
Such growth could continue "for another year or two, perhaps three," said the second analyst, "but the global economy is cyclical, and at some point, we will experience a downturn compared with what we saw last year."

The glass half empty view from CBSMarketWatch:

Oil development may not brake prices
Cambridge Energy director says reserves not key issue

By Lisa Sanders, MarketWatchLast Update: 1:36 PM ET Feb. 15, 2005
HOUSTON (MarketWatch) -- It's not that there isn't enough oil in the world. It's that it may not be developed in time to halt rising crude prices, a Cambridge Energy Research Associates director said Tuesday.
Speaking in Houston at an energy industry conference, CERA's Peter Jackson said it would be some time before the world runs out of commercially viable reserves. Earlier Tuesday, ChevronTexaco (CVX: news, chart, profile) Chairman and CEO David O'Reilly said he expects hydrocarbons to contribute to energy supplies through the midpoint of the century. See full story.
"Setting aside above-ground political and security issues, world oil production capacity through 2010 points toward continued growth in both non-OPEC and OPEC liquid-production capacity," Jackson said.
The research firm predicted total liquids capacity would rise nearly 20 percent to 101.5 million barrels a day. CERA said most of the increase would come from projects in the deepwater offshore Brazil, Nigeria, Angola and the Gulf of Mexico. The Caspian region and the Canadian oil sands are also expected to make significant contributions.
"To be sure, there are risks to supply growth," Jackson said. Those include higher field decline rates and delays to major projects.
"Perhaps the most unpredictable and sensitive factor is evaluating the impact of political events on productive capacity as illustrated currently in Iraq, Venezuela, Nigeria and Russia," he said. However, CERA has factored in many of the wildcards to its outlook.

$60 before $40.

T. Boone Pickens on CNBC [video] today reiterating his prediction we hit $60 a barrel before we see $40 a barrel again. He made a number of observations:

- The Russians want $50 oil.

- The Saudi Arabians are doubling their active rig count, but he believes it's probably more to try to maintain their current production capacity than increase it.

- He believes Saudi Arabia is now also more inclined toward $50 oil, versus the $40 they were favoring recently.

- In response to a question on oil sands and their potential, he noted that it takes an investment of $20 billion to create the infrastructure to produce 1 million barrels a year of oil from them.

- His view is that using natural gas to generate power is a waste; nuclear and coal should be used to produce power and we should shift to using natural gas as a transportation fuel as they already are in other parts of the world. [The WSJ has a front page article [$] about this today.]

1,000,000 Becky Quick Fans Can't Be Wrong.

Actually, I read somewhere that CNBC viewership is down in the coupla hundred thousands these days. [The bubble folks, apparently, are over watching HGTV.] But when there's somebody with an interesting viewpoint on CNBC, FoxNews or Bloomberg I fire up the old Tivo.
Here's my list - not meant to be comprehensive, but enlightening nonetheless - of intelligent folks who have mentioned energy as a favored sector due to the supply/demand imbalance. This is roughly over the past 3 months.

Jim Rogers
John Bollinger
Ken Heebner
Wayne Rogers
T. Boone Pickens
Charles Maxwell
Peter Thiel - Paypal founder
Louis Navallier
John Roque
Jim Cramer
David Swika

This gentleman is also of the same mind, though he's not coming from an investment angle:
Michael Economides - Professor of Engineering, U. of Houston

I'll probably post an addition sometime later, I've got a backlog on my Tivo.

Ben, I have just one word for you, one word: "plastics".

ExxonMobil is approaching the market cap of the largest company, General Electric.

This brings to mind a thought I had a while back. Is energy the new tech?

Pop quiz: What do many people require every day, ad infinitum?

1.) The Internet.
2.) Pets.com
3.) A new PC.
4.) A Cisco BMF Router.
5.) Energy.

The other thought I had in mind: Is energy the new gold? Inflation hedge/end of the world hedge/dollar declining hedge.

I don't know the answer, I just had those questions running around in my head. [Plus this image of Jennifer Garner in a schoolgirl outfit, but I digress.]

P.S. You probably already know this, but most plastics are made with hydrocarbons.

Oil, oil everywhere. ... ?

I just ran across this WSJ editorial, it's actually two weeks old, but I like to read the con side of the argument, to see what they're thinking.

The authors suggest that there's a lot of oil waiting out there, that it is not terribly costly to extract and won't be for a while, and that the main problems are that much of the cheap oil is in volatile regions, and we haven't chosen to invest in the other areas (Canadian oil sands primarily) that could produce more because Saudi Arabia could basically open the spigots on their low cost oil and wipe out our investment overnight.

Ok. Couple of problems.

If there is so much oil out there, why isn't anybody running across it? Folks are exploring many places (ask the Chinese) and yet the number of big finds is down to essentially zero. Many areas of the Middle East are restricted, so it's not clear what exactly their situations are since there are questions on the accuracy of their reserve estimates.

Secondly, costs are escalating as ExxonMobil would tell you (see mention of Caspian area in prior post). In fact, the major oil companies generally [registration required] are buying back stock, buying other companies, or paying dividends rather than raising exploration budgets sizably. Some suggest this is a "capital discipline" move on their part, as oil companies get nervous oil prices will eventually collapse like they did in 1998. Others suggest it's because there's just not much left to explore except the deep sea, which is very expensive. But if $47 oil isn't incentive to poke around more, something's probably up.

Finally, oil sands, while promising and sizeable, cannot entirely fill our needs. Oil sands involves essentially manufacturing oil, not extracting it. There is a big difference in the process as well as the cost. The plants are expensive, require maintenance, break down, have certain production volumes. I am no expert, but I doubt they could ever be anything more than an adjunct to other oil supplies, given the current demand for oil. And keep in mind turning oil sands to oil requires prodigious amounts of natural gas.

Finally, on the question of Saudi Arabia opening the spigots, flooding the market and driving down prices, they already did that as part of their "Get out the vote for Bush" campaign this summer. That sure worked, but oil prices buckled but did not break. In my opinion, that really says something.

Two positives to report.

Venezuela, which supplies a goodly amount of oil to the US, reaches an agreement with ConocoPhilips on a promising field. This is an agreement that was signed a while ago, but got held up as Chavez made noises about wanting a better deal, dealing instead with the Chinese, selling below market to Cuba, etc.

And China claims it has added 25% to it's reserves. Actually, I was just wondering what Shell's old accounting firm was up to these days..

Oil changes everything.

From an article on TheStreet.com: Oil jumped 4% on Thursday alone and ended the week at $47.16, up 5% from its Tuesday morning low. The International Energy Association (IEA) was the big mover on Thursday, revising its global forecast for 2005 to include higher demand and limits on supply growth.
China continues to surprise the IEA on the upside. The country used 16% more oil last year -- an increase four times greater than the overall rise in global demand -- and the IEA currently forecasts another 6% jump from China in 2005. Meanwhile, production in Russia could come under pressure, and OPEC is operating with little ability to increase production, the group said.

"The factors that contributed to the rise in oil prices throughout 2004 show little signs of abating in 2005," Merrill Lynch's energy team wrote in a report after the IEA forecast. OPEC's is running up against production constraints to add more supply, global demand will rise about 2.2% and the risk of "supply disruptions" remains high, the firm said. They're forecasting an average price per barrel of almost $46 on the Nymex futures exchange for 2005.

As a result, year to date, energy is up 7%, the top-performing of 10 broad sectors on a capitalization-weighted basis, according to Morningstar. Looking at more detailed performance of over 120 industries, oil and gas products is the leading group, up 14%, led by Valero Energy's (VLO:NYSE - news - research) 35% gain and Sunoco's (SUN:NYSE - news - research) 16% rise. Oil and gas services has gained 9%, with leaders including Pride International (PDE:NYSE - news - research), up 18%, and Rowan Companies (RDC:NYSE - news - research), up 17%. Also among the top 10 best-performing industries are oil and gas majors, up 7%, pipelines, up 5% and coal producers, also up 5%.


My obvious observation: Oil companies are going to be making a lot of money at $46 a barrel.

Going up.

Jim Cramer of CNBC and TheStreet.com notes on his radio show that oil now makes up 8% of SP500, versus two years ago when it was 5%. His theory is it goes up to 10%. He also mentioned the strong moves in the Canadian oil stocks. I have to say, I don't know much about charts, but when you look at the charts of many of the oil stocks, they almost look like they're aching to go higher.

Talking my book.

As many of the oils hit 52 week highs, I am hesitant to jump on board further. I personally am overweight energy in the form of VGELX, FSESX, PRENEX, CNQ, ECA, CNX, CHK, TXCO, BTU. I like a few others and will be keeping an eye out: XEC, XTO, SWN, UPL, BR, COP, PCZ, SU, NXY, TLM, STO, SSL, APA, MUR, IMO, XOM, BP, SC. As you'll notice, that list is not restricted to oils, instead includes natural gas and coal. Energy is the focus, and I think this is a multi year move.

Peak Oil Thoughts.

Peak oil: the theory that given the fact that the supply of oil is limited, there is some roughly halfway point at which oil production peaks and subsequently declines. (Visualize the Bell curve: up, a peak or plateau, then down. Here's a diagram.)

This theory, as with all really good ones, was first laughed out of the room when presented in the 1950s by Shell geologist M. King Hubbert on US oil production. (By the way, he came up with his theory from observing the production of an individual oil well, extrapolated to an oil field, then further to the lower 48 states as a whole). His prediction that US oil production would peak in the 1970's turned out to be correct and now the theory is known as Hubbert's Peak.

People have now applied his formula to world oil production and are coming up with a time frame for peak oil of roughly 2000 (!) - 2015.

Some people confuse peak oil with oil depletion, the idea that we will run out of oil. Maybe some day, but long before we run out, oil supplies will get tight. That is peak oil. If the world is demanding 82 million barrels a day (a day!), and oil production starts to decline below that, obviously there's a bit of a problem.

One which, thankfully, capitalism will solve, though unfortunately not in the way we normally would hope. Rather than supply rising to meet demand, demand will have to fall to meet supply, and the adjustment will involve price.

So how do we tell if peak oil is here? Simple: Oil production will peak, plateau, then decline. Prices will rise, though probably be quite volatile as they go through "price discovery", trying to find the right balance between supply and demand. Which is to say, oil prices will trend up, but probably be all over the place.

Further reading on Hubbert's Peak and a prediction of a peak oil production date of Thanksgiving 2005 from Princeton professor Kenneth Deffeyes, who worked with Hubbert, here, and a recent presentation of his is available here. He also wrote a couple of good books on the subject, see sidebar.

An interesting paper on the topic here, maybe a little dated but still interesting.

Mainstream media has caught on too, with articles in National Geographic, Newsweek, CNN/Money, US News and World Report, and WSJ.

3 out of 3 knowledgeable investors recommend..

Suncor (SU).

A Canadian oil sands play. In the recent past, and at somewhat lower levels, I've heard this recommended by Jim Rogers, T. Boone Pickens, and Charles Maxwell. I don't know about you, but I'd say these are three guys who know a little about oil and making money.

The basic idea is that the company has a huge amount of potential oil reserves in it's oil sands, with the added bonus that it's close nearby and in a fairly stable country. [Though you never know when one of their politicians is going to get a kink in her skirt and call our President an idiot, but I digress. Thank God they have democracy over there or ...]

Oil sands are apparently just what they sound like, a mix of oil and sand that must be mined and separated to produce a lower grade of crude oil. The catch is that the process is seriously energy (generally natural gas) and water intensive, dirty as all get out, and has significantly higher costs than regular oil wells. However, as oil prices rise and stay elevated (above $35 is particularly good), oil sands become cost effective and profitable.

(Disclosure: I own no SU, though I plan to buy it at some point in the next 6 months.)

"Energy Challenges" alright.

As part of my research, I checked out ExxonMobil's [Great quarter, guys! - do they say that on the conference call like they used to with the .coms?] web site where they report under "Energy Challenges" that we need 78 million barrels of oil a day. Uh, folks, it's actually something like 83 million barrels a day now. And growing. But hey, the page says 2001 and they've apparently been busy. But not too busy as they've decided to stop drilling the Nakhichevan field in an area of the Caspian Sea after failing to find much. The Caspian Sea is another of the world's more promising areas. We think..

Them darn Ruskies.

Yesterday, the Russian government announced that henceforth only majority (51%) Russian owned companies would be allowed to bid on major oil fields this year. Since Russia is, er, was considered one of the few areas that oil majors might have been able to find some breathing room in terms of promising new reserves, this isn't a favorable development.

WSJ quotes a Western industry official as saying "This sets a bad precedent." (Apparently they found the one gentleman in the industry who lay in a coma as Russia dismantled OAO Yukos.)

Oil prices jumped, as did oil stocks. Looks like them Russians caught on that this oil stuff was worth a few bucks. Interestingly, Russian growth in oil production appears to be trending lower.

As an aside, I've read that if Russia's economy hadn't been a train wreck through most of the 90's, their internal oil needs would be a lot higher and their oil exports subsequently lower with the supply/demand equation in the oil market consequently much tighter.

In the beginning..

As I start this today, I notice that Merrill downgraded both CNQ (Canadian Natural Resources) and ECA (Encana) from BUY to NEUTRAL.

Not an auspicious start, I suppose.

Probably a valuation call; nothing like a pricey oil to scare the dickens out of an analyst. Anyway, more about these two later. (Disclosure: I own both stocks.)