Oils Well That Ends Well

It looks like our overpaid Congressfolk are at it again - flexing and preening for the American public. This time the House has approved a law that would allow us to sue OPEC for high oil prices. They'll debate and pontificate about limiting frivolous lawsuits and excessive malpractice awards but then turn around and pass a law like this? It makes me pine for the glorious days of the Truman-era "Do-Nothing Congress". Good times.

Before getting to the new OPEC law, let's look in at today's Senate Judiciary hearing which is questioning oil executives about the rise in oil prices. Here's my favorite quote so far, and it comes from Senator Patrick Leahy, D-VT: "Normal supply and demand says prices should be around $55 to $60 a barrel."

Where does he come up with that? This guy must be pretty flexible to reach around and pull those numbers out of his ... assistant. Seriously, Mr. Leahy is incredibly arrogant to think that he knows what the "real" price of oil should be and to think that the market has it so incredibly wrong. I'm sure he also knows the "real" price of health care, ethanol, interest rates, rice, wheat, housing bailouts, etc. Ah, to be blessed with the intelligence of Mr. Leahy!

Back to this whole suing OPEC farce. This is a joke on many different levels. Let's start with the fact that one of the biggest gasoline bottlenecks we face comes from a lack of refinery capacity, and Congress certainly isn't doing anything to address that. Even if OPEC could immediately double its production, it would be irrelevant since there isn't enough global refining capacity to turn it into gasoline. Similarly, if my income suddenly doubled, it wouldn't be relevant since my wife couldn't spend it fast ... bad example.

Second, if anyone thinks that OPEC isn't pumping pretty much full-out at these oil prices, they're probably crazy enough to be running for office. When I say "full-out", I'm talking about maximum rates without damaging the oil fields, but I wouldn't be surprised if some countries were producing above such levels. Furthermore, it wasn't that long ago when OPEC was faced with $10/barrel oil. We certainly weren't rushing to subsidize them at those levels or accusing them of overproducing.

I won't get into the details of Peak Oil in this article, but there has only been one truly major oil discovery (offshore Brazil) since the mid-1970's. This includes OPEC countries where we think the oil just bubbles out of the ground. They've been picked over. The easy oil has been discovered. There is plenty of other oil still out there, but it's expensive to find and develop. It's buried deep below the ocean, in oil shale deposits, in tar sand deposits, and in hostile regions like the Arctic. It will take a high oil price to make this exploration and development economically viable, so trying to constrain oil prices isn't going to be encouraging the development of additional supply.

Then there are those (presumably including the members of the House who voted for this bill) who believe that oil prices at these levels are based largely on speculation by Wall Street types. I imagine this is a minor factor, but you can blame the Fed for this being a factor at all. Given the debasement of the dollar, who can blame anyone for preferring to own real hard assets (like oil) instead of dollars? Also, if these prices are being driven largely by speculators, why has the price of oil continued to make new highs in the days following the announcement that the government would stop adding to our Strategic Petroleum Reserves? The price is hitting new highs because there is no longer a supply cushion, and developing countries like China and India have a voracious appetite for oil.

Next, we have the Europeans who are paying between $6-7 a gallon for their gasoline. We don't hear them whining. I imagine their legislators are spending their time on less economically destructive endeavors like watching Dr. Who, going on fox hunts, and rioting at soccer matches.

I also have a bit of a logic issue with this new law. If you've been bitten by a snake and you're not happy about that, why would you turn around and poke the snake with a stick? If we really do think that OPEC has idle production capacity, why are we antagonizing them? Shouldn't we be making nice? We're not really in a position of power. Are we going to threaten to stop buying their oil? Stop laughing -- that was rhetorical. I think we're all familiar with the quote, "You attract more flies with honey than by poking them with a stick."

Here's the point that I believe is most interesting. If you were to ask every one of our congresspeople if they are pro-environment, every one would say yes. Most are also concerned with global warming and actively want to address it. Many also want to spend our tax dollars on helping to develop alternative energy sources. If they are really so concerned with the environment and the energy crisis, then why in the world would they want to do anything to limit the price of oil and gas? The single biggest driver of the development of alternative energy sources is higher oil and gas prices. For example, high oil and gas prices are making solar and wind power more economically viable. No one knows what the leading energy sources will be in 50 years, but with oil and gas prices as high as they are, the incentive is there for private industry to solve this problem. We don't need folks like Mr. Leahy spending our tax dollars as they see best, and we definitely don't need to be suing OPEC.

As for strategy, I've been bullish on energy for quite a while and remain so. Having said that, I continue to lighten on price spikes and rebalance as necessary. I continue to like a number of names including PBR, ESV, and NOV. Briefly, Petrobras was added following their discovery of the huge offshore Tupi field. The cost of developing their deep offshore finds will be tremendous, but PBR has a very good chance of becoming one of the leading oil producers in time as production ramps significantly over the coming decade, and there is, of course, hope of future large discoveries. As for Ensco, they are one of the largest offshore drilling contractors. They have one of the lowest fleet ages, a growing deep water capability, and one of the most attractive valuations in the space. With talk of Petrobras trying to lock up as many deep-water rigs as possible, the future looks bright for ESV and its peers. National Oilwell Varco has its hands in every aspect of the design, construction, and service of most of the systems and components used in oil and gas drilling and production. This includes the construction of rigs which is likely to benefit from increased drilling, particularly offshore.

As much as I like the fundamentals of these firms, I am not adding to them at these levels, given the recent run in oil and oil-related stocks. Sentiment has turned very bullish for this entire space over the past couple of months, and the space is due for some consolidation. Should the oil complex continue to move up near term, I would anticipate taking some profits or initiating a short-term hedge. I have, however, recently added a new position in Petrochina (PTR) at levels not too far below the current price and would look to add further on pullbacks.

As for our government, it they want to sue someone over price gouging, maybe they should go after Starbucks. The price of my Venti mocha works out to about $1,075 per barrel. Keep that in mind the next time you're filling up your tank.