The Oil Industry: We’re a Few Months Away From $100 Oil…
by David Fessler, Energy and Infrastructure Expert
Friday, November 13, 2009: Issue #1137
It’s the oil industry’s version of War and Peace.
I’ve spent this week poring over the 2009 volume of the International Energy Agency’s (IEA) World Energy Outlook.
All 698 pages of it.
And what I’ve read so far sends shivers down my spine. Let’s start with the good news…
Temporary Relief From Rising Oil Prices
According to this year’s report, the recession and financial crisis gives us temporary relief from the fossil fuel demand and rising oil prices. Indeed, 2009 will be the first year since 1981 that global energy use will actually fall.
Unfortunately, that’s where the good news ends. From next year, fossil fuel use – and oil in particular – will ramp up again. Consumption is projected to grow by 1% per year through 2030. And you can blame it on skyrocketing demand from emerging market countries.
And it’s this resumption of demand – coupled with a possible shortfall in exploration and production – that’s a recipe for disaster.
The Oil Industry & The Paradox of Oil Prices
From the IEA’s World Energy Outlook: “Any prolonged investment downturn [in oil exploration and production] threatens to constrain capacity growth, eventually risking a shortfall in supply. This could lead to a renewed surge in prices a few years down the line, when demand is likely to be recovering and become a constraint on global economic growth.”
This, dear reader, is the paradox of oil prices – and it’s playing out right in front of us right now.
- During “normal” economic times: rising demand leads to increased investment in exploration and production. The end result is that supplies eventually increase, and prices subsequently drop (or go up less rapidly).
- During recessionary periods (like today): unemployment rises. And the unfortunate people without jobs drive less and demand for oil consequently drops. This also causes a supply glut and a subsequent drop in oil prices.
In 2008, we saw a situation where oil prices fell all the way down to $35 before the OPEC cartel managed to cut supplies enough to cause prices to slowly rise. But the damage was already done.
Result: exploration came to a virtual standstill. Rigs were mothballed. Drill ships were anchored – not in thousands of feet of water, but floating idly in harbors across the world.
Today, we’ve got tight credit markets thrown into the mix. And even with demand returning, investment in new exploration and production will slow. In fact, that’s already happening. According to the IEA, 2009 will see a 19% cutback in oil and gas investment. That’s $90 billion that won’t be going into finding more oil and gas or bringing new finds into production.
My friend Rick Rule likes to put it this way: “The cure for high prices is high prices and the cure for low prices is low prices.”
Of course the effects of this phenomenon vary widely between companies and a large part of it depends on production costs. Let’s take a closer look at what makes up the cost of a barrel of oil.
The Oil Industry’s Three Components of Oil Extraction
Extracting oil out of the ground to the pump at your local gas station is essentially divided into three components by the oil industry:
- Finding costs: These are those costs associated with actually finding an oil deposit, determining its size (and thus its commercial viability) and developing the field. According to data from the Energy Information Administration (EIA) this component can vary widely – from $4.77 a barrel in the Middle East to $49.54 for the U.S. offshore.
- Lifting costs: These are costs associated with physically bringing the oil to the surface. The characteristics of the reservoir, its depth and the actual consistency of the oil are the main factors affecting the cost of producing the oil. According to the EIA, lifting costs can range anywhere from $3.87 a barrel in Central and South America to $10.00 a barrel in Canada (oil sands).
- Total upstream costs: This includes transporting the crude, refining it into finished products and transporting and distributing those to end use points.
Today, more oil is coming from deeper and deeper locations, which results in higher finding and lifting costs. You can see this trend in the graph from the EIA.
So what does this mean for investors?
Simply put, with oil prices currently hovering around $80 a barrel – and set to rise – oil companies are beginning to pump money back into finding more oil. That’s good news for the companies who drill for it.
Three Oil Companies That Stand to Benefit From Rising Oil Prices
Here are three companies within the oil industry that stand to benefit from rising oil prices…
- Atwood Oceanics, Inc. (NYSE: ATW) is an international offshore driller. The fact that its shares have soared by 159% since the beginning of 2009 signals a return to exploration and production by the major oil companies. Still, with a P/E ratio just over 9, it offers investors a good opportunity to play the offshore drilling space.
- Superior Well Services, Inc. (Nasdaq: SWSI) is engaged in technical pumping and surveying services. It operates from 36 centers across the United States and has a fleet of 1,628 vehicles. It also provides for, and disposes of, fluids used in hydro-fracking of oil and gas wells.
- Weatherford International Ltd. (NYSE: WFT) is a larger and more diversified version of Superior. Operating in over 100 countries, Weatherford provides services and equipment used in the drilling, evaluation, completion and production of both oil and natural gas wells. Weatherford shares are up 72% this year.
In summary, with oil prices set to rise over $100 a barrel next year, drillers are benefiting from some of the major oil companies who are once again starting to crank up their exploration and production budgets.
Good investing,
Dave Fessler
Any investment contains risk. Please see our disclaimer.
9 Responses to “The Oil Industry: We’re a Few Months Away From $100 Oil…”
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David Fessler is the energy and infrastructure expert for Investment U.
You didn’t mention the premier company in the group–Transocean(RIG)
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How come I never hear much of anything regarding a very large concentration of oil in the Dakotas called BAKKEN. I have heard of huge reserves located here. Why are we fooling around with the mideast, if BAKKEN is true we could easily be less dependent on reserves outside the US and with drilling and refinning, could provide thousands of jobs for AMERICAN CITIZENS.
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Lars,
We did some digging on the Bakken deposit and were able to find this link to Snopes.com. Snopes goes on to say that the information you received on the Bakken reserve was taken from a “tout sheet” intended to sell subscriptions for a nameless investment newsletter and that the recoverable amount of oil (500 billion barrels) is overly optimistic and based on incomplete, outdated information.
Here is an excerpt per Snopes.com: “The U.S. Geological Survey (USGS) released it’s assessment of undiscovered oil resources in the Bakken formation in April of 2008, and although it reported a 25-fold increase in the amount of oil that could be recovered from that area compared to its 1995 estimate, the 2008 USGS estimate was still far short of the 503 billion barrel volume cited [in the information about the Bakken reserve that you may have heard of/received.]
The USGS estimate was a mean value of 3.65 billion barrels, and while that is nothing to sneeze at, a little perspective is in order. The U.S. currently imports an average of around 10 million barrels of oil a day – totalling 3.65 billion barrels a year – so if all of the Bakken formation oil was extracted it would only wean the U.S. off of imports for one year.”
You can read more on that here, on Snopes.com:
Thank you,
Investment U
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Looks like some real work went into this project. Whether or not these “experts” are correct is questionable but gives a lot of things to think about before buying stocks.
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I cannot see how anyone can say and keep a straight face while doing so that the recession is over. Isn’t the real measurement of the end 2 or more quarters of rising GDP along with falling unemployment?
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How about recommending an oil ETF?
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From the inside on Weatherford, a hopeless bureaucracy that makes any government look efficient, for real oil profits look elswhere, as an insider I would never buy this company. Weatehrford only survives on Acquisitions, it is incapable of real growth, especially on the service side. its price drops farther than the competition when times are tough, and only rides a wave of true companies that provide real service in the industry. I can’t believe you would be fooled by their numbers in your analysis
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that is really helpful and sobering. Its hard not to believe the information that you read when you come to trust a certain expert or newsletter and hearing from someone who works in the company puts the brakes on a bit. I am very interested in the psychology behind buying and selling and I’m looking at my own behavior first. Like everything else, sometimes a company goes up from buzz(is that the word) alone and has nothing to do with how substantive the company is.
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I disagree.According to an industry honcho(read as CEO of EXXON) today on Bloomberg, other experts and the trading communoty, the current price of oil contains a shaare of 20 to 25 % due to the devaluation of US dollar.
Based upon the real value defined by the requirements in the developed and emerging economies, the price should be around 60 Dollars.
In 2012 onwards,the demand will go up, as the world economy improves, inflation will rese, but so will the dollar.
The overall effect may still be neutral or only marginally positive.
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