IEA Whistleblower Buoys Peak Oil Theory

There's a terrific piece in the Guardian today entitled "Key oil figures were distorted by US pressure, says whistleblower." The gist of the story is that the IEA has been intentionally overstating future oil supply estimates in order to prevent a panic. Some key passages:

"The IEA in 2005 was predicting oil supplies could rise as high as 120m barrels a day by 2030 although it was forced to reduce this gradually to 116m and then 105m last year," said the IEA source, who was unwilling to be identified for fear of reprisals inside the industry. "The 120m figure always was nonsense but even today's number is much higher than can be justified and the IEA knows this.

"Many inside the organisation believe that maintaining oil supplies at even 90m to 95m barrels a day would be impossible but there are fears that panic could spread on the financial markets if the figures were brought down further. And the Americans fear the end of oil supremacy because it would threaten their power over access to oil resources," he added.

A second senior IEA source, who has now left but was also unwilling to give his name, said a key rule at the organisation was that it was "imperative not to anger the Americans" but the fact was that there was not as much oil in the world as had been admitted. "We have [already] entered the 'peak oil' zone. I think that the situation is really bad," he added.

This is huge news as many of the Peak Oil doubters had depended on IEA data to bolster their case. It also speaks to the unreliability of official statistics. If non-OPEC data is being so severely manipulated, just imagine how absurd OPEC numbers must be.

The days of inexpensive and easily accessible oil are over. There is still plenty of oil buried very deep offshore West Africa, Brazil, and in the Gulf of Mexico. Other deep plays are sure to be discovered as well, and the Arctic region holds great promise. The tar sands also hold a great quantity of oil. None of these plays, however, are inexpensive. High oil prices will be required to justify the investment needed to explore and develop these reserves.

These high oil prices will also be the incentive the market needs to develop alternative energy sources. The higher the price of oil goes, the more competitive the alternatives become. Still, this shift will take decades. In the meantime, higher oil prices will be a boon to much of the traditional energy sector.

We are long a number of E&P and energy service stocks. There will be bumps along the way, but energy should be a winner in the coming decade.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Chart Of The Day: Cantarell

Last year, I wrote about the likely peaking and production decline of some of the world's largest oil fields. The best example remains the once-giant Mexican Cantarell field. The following graph of production from Cantarell is simply stunning. Production from this one field has fallen one million barrels per day in just the last few years.



Much has been made lately of some recent exploration successes offshore Brazil and in the Gulf of Mexico. Many are claiming that these successes prove that the threat of Peak Oil is false. When it comes to the Peak Oil theory, however, the key point to remember is that it refers to easily recoverable oil. Higher oil prices will be necessary to support the very costly exploration and development efforts necessary in the deepwater and (eventually) Arctic frontier plays. The future production decline from the world's aging major oilfields will need to be replaced, and the most likely source will be much higher-cost less-traditional sources.



Disclosure: Aspera Financial, LLC is long a number of energy-related stocks and natural gas.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Chesapeake - Never Boring

At the beginning of 2008, Chesapeake had a market value of $23 billion. Four months ago this company had a market value of $43 billion. A few weeks ago, that market value had fallen to $7 billion, and today it stands at $12.7 billion. I'm getting a bout of vertigo just typing these numbers.


I know what you're thinking. "What's the big deal? All of the banks are getting killed these days." That's fine, but this isn't a bank. This is the largest independent producer of natural gas in the United States. They have a strong exploration and production track record and hold some large and interesting acreage positions.

$43 billion to $7 billion in a few months. That's a decline of over 80%. That works out to over a 300% annualized loss (it's the new math). Immediately, one's thoughts wander to Enron. These guys must have been cooking the books. They must have overstated the amount of natural gas reserves they own, right? Wrong. So what's going on here?

For starters, we have to put that 80% decline in context. The market overall hasn't been exactly kind to anyone since the end of July. From the time of CHK's peak to its bottom earlier last month, the S&P 500 fell about 30%. It didn't help that natural gas prices fell 53% over this same time period in sympathy with oil prices (down 43%) as the global economy continued to sputter. XOP, the SPDR S&P Oil & Gas Exploration & Production ETF, was down 62% over this period. Still, CHK has outdone itself by falling further than any of these.

There is an added wrinkle to the CHK story. Chesapeake's CEO, Aubrey McClendon, owned about 32 million shares of CHK on October 8th. A couple of days later, most of those shares were gone. Loss of confidence in the company? Not exactly. McClendon was hit with a margin call. Amazingly, this billionaire thought it wise to keep adding to his already sizable CHK stake by buying on margin as the stock started falling this summer. You have to admire his belief in the company while questioning his money management strategy.

It boggles the mind that a billionaire would risk his fortune by buying stock on margin and not diversifying his holdings, but that's what McClendon did. This is a massive failure in Financial Planning 101. Amazingly, he wasn't alone. We've been learning of executives at other firms (see BSX, CPE, DNR, LTM, PROV, PHM, and WSM) also experiencing margin calls, although of a lesser magnitude.

McClendon was forced to unload 31.5 million shares between October 8th and 10th at an average price of just over $18/share. He sold 1.8 million of those shares as low as $12.64 on the 10th. Ouch. With the stock now back at $22, that forced sale has "cost" McClendon another $125 million. Ouch. It doesn't help that this margin call occurred as the market was gapping down to a new low on the 10th.

You can see in the chart below that from the peak on the 9th to the low on the 10th, CHK lost about 50% of its value. With about half of McClendon's shares hitting the market on the 10th, it's pretty safe to assume that the extra 15 million share of selling pressure somewhat exacerbated the stock's decline. Not surprisingly, with that selling pressure now abated and with the market a bit higher, CHK has rebounded a tremendous 83% from its intra-day low on the 10th.


This is all water under the bridge at this point. The more pertinent issue is what to do with the stock now. Is the stock attractive at this level, or is this a value trap? As I've shared in the past, if I can't figure out that a company is inexpensive on the back of an envelope then it isn't worth my time or money. And, as always, I encourage everyone to do their own work.

With that said I'd like to share a couple of comments from last Friday's quarterly earnings conference call (10/31/08) that caught my attention. Chesapeake CEO, Aubrey McClendon, started off the call with an interesting statement:

First, we open the third quarter with a bang, in announcing a very innovative sale of 20% of Chesapeake's Haynesville acreage position in the Plains for $3.3 billion in cash and drilling carry. This was a great transaction for both parties and established a $13 billion value for our remaining 80% in the Haynesville, a value that today ironically exceeds our entire market cap. That does seem very unusual to me.

What makes this even more intriguing is that the Haynesville play accounts for only 20% of the company's total proved and risked unproved reserves. We can argue all day and night about the pros and cons of shale gas production, but this is an actual deal with a knowledgable buyer, so it's hard to dismiss it. To be fair, however, this deal was struck back when natural gas prices were near their peak, so I don't believe for a minute that the company would fetch $13 billion for its remaining 80% today. In defense of management, however, their timing on that sale was impeccable, or impeccably lucky.

McClendon continued,

Second, in early August, we completed another innovative JV transaction, this time in the Fayetteville Shale with British Petroleum to whom we sold 25% of our Fayetteville assets for $1.9 billion, leaving our remaining 75% position in the Fayetteville worth about $6 billion or roughly $10 per share which is about one half of our stock price today. For the record, only about 4% of our proved reserves are booked to the Fayetteville yet this transaction alone established a remaining Fayetteville value equal to 50% of our stock price; again, very unusual.

Again, natural gas prices have fallen since that time. Still, these transactions provide a bit of support and some margin of safety. The company has more of these deals in the works. It will be interesting to see what type of value they receive and its implications for the entire company's valuation.

As I always stress, I don't pretend to know what any stock or market will do in the short-term, but this is the type of situation I like. We have a real company with real assets that is currently out of favor due to a recession of questionable length and severity. If you believe that the recent flood of bad economic and financial news around the world is a sign that the rapture is near, then you'll probably want to pass on this stock (and every stock). Of course, if you believe the rapture is near, why are you wasting your time reading this? If you believe that the economy will eventually recover and you have a long-term horizon, then the following points are worth considering:

• As with many stocks, this sector is best bought when it's out of favor. Check.
  
• Current natural gas prices aren't too far from average industry all-in cost levels. This may provide some price support.
  
• Natural gas wells deplete fairly quickly, on average. This helps to balance supply when activity slows due to excess demand.
  
• Most everyone is expecting the rig count to continue falling in the coming months, further reducing expected natural gas supply.
  
• Natural gas is much cleaner than oil and much closer to home. Demand is likely to resume growing following this recession.
  
• CHK's balance sheet looks fine. They have no large near-term debt maturities, they have a nice chunk of cash, and they should generate significant excess cash in coming years.
• Valuation looks very attractive on a number of metrics.
  
• McClendon has to be angry given how much money he recently lost. He probably has a nice-sized chip on his shoulder right now. I wouldn't bet against him.
  

Importantly, natural gas is a self-correcting market. Lower prices result in less drilling which leads to less supply which leads to higher prices. The only real question relates to the length of time it takes for this to occur, and that depends on how far and fast natural gas prices decline, how quickly firms pull back on their drilling, how quickly wells deplete or are shut-in, and how severe the fall off in demand is. But make no mistake, the stage is again being set for a period of tight supply, higher natural gas prices, and higher equity valuations for this sector.

Disclosure: The Rubbernecker is long CHK and short the rapture.

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The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Yes! There Is Intelligent Life In D.C!

I'm in a slight state of shock at the moment. It isn't terribly often that I agree with something that comes out of the mouth of a senior government official, regardless of the administration. However, I just read the transcript of a speech that Under Secretary for International Affairs, David H. McCormick, recently made concerning the oil market.

I don't know where this government employee gets off thinking clearly and making sense. Perhaps you're still permitted these luxuries when you're a mere Under Secretary. Perhaps he's positioning himself for a cozy job at a think tank in a few months. Perhaps he was drinking. Regardless, the piece is a little dry, but Mr. McCormick does a very nice job of summarizing what's been happening in the oil market in recent years.

If you'd like a nice little primer, the full article can be found here.

Tis The Season

It's been a slow week posting-wise thanks to a busy week earnings season-wise. Earnings season is always a bit of a mind-numbing experience. Every day is met with a barrage of press releases, numerous analyst rating changes, and back-to-back conference calls with management explaining how their quarterly earnings would have been an all-time record if you just ignore the write-offs, higher commodity costs, lawsuits, accounting system transition issues, margin shortfall, higher tax rate, options expense, weather impact, goodwill amortization, order push-outs, and poor feng shui. It makes for some long days.

Of course, there are companies reporting good earnings -- mostly commodity-related companies, those benefiting from international growth and the weak dollar, and those that operate pawn shops. Those with the most excuses are the financials. The typical bank conference call this quarter can be summed up as follows:

We’re disappointed to report a record loss of 12 kajillion dollars, but our core business is performing strongly as you can see if you strip out the mark-to-market losses and the charge-offs.

Well, if I ignore my lack of buoyancy and my inability to breathe in the water, then I'm a world-class swimmer. They’re a bank! The purpose for their existence is to attract deposits/funds and invest the proceeds in securities and loans. It’s like Microsoft saying, “We had a great quarter aside from terrible software sales.”

Let’s be very clear. When a bank has to charge-off a good chunk of its loans, it's an admission that prior period earnings were overstated. Prior earnings benefited from these loans back when borrowers were actually making their payments and the bank wasn’t adding to reserves. These guys want the benefit of the overinflated prior period earnings but no penalty for the current period charge-offs. It would be genius if it weren't so ridiculous.

Despite some truly poor earnings in general from the financial sector this quarter, we did witness a very robust rally in the group. This wasn't terribly surprising. As I wrote on July 15^th in my Trader VIX post,

...the VIX has had an uncanny ability to predict short-term rallies (lasting between 2 weeks to 3 months) in the S&P 500 (top chart) each time it has exceeded 30 in the past year. As the VIX has approached this level, I've been less inclined to initiate new short positions and more inclined to cover existing shorts. Note that the intraday high for the VIX today was 30.81.

It seems I wasn’t the only one watching the VIX. Almost as soon as the VIX crossed 30, the market made its most recent low and began its latest bounce. With financials having been sold-off so brutally over the prior 2 ½ months, it was no surprise that they benefited the most from the rally.

Also from the Trader VIX post,

In general, I'm expecting plenty of earnings misses and fairly restrained (to put it mildly) earnings guidance over the next month. But, with cash on the sidelines and a pervasive sense of gloom in the market, an earnings season short of cataclysmic may be just enough to spur the next bear market rally.

This also turned out to be the case. Prior to Thursday, the S&P 500 rallied more than 6% over a mere 6 trading days. Generally speaking, the earnings results from the financials were awful, but since they turned out to be less terrible than feared, the group enjoyed a powerful rally.

The other strong move of note this month has been the sell-off in practically every commodity and commodity-related company. I’ve been cautioning that this would happen at some point and that this is normal bull market activity. I had pared back exposure to the group and have been keeping some dry powder ready for just such a pullback.

In recent days, I’ve been gradually putting some of that dry powder back to work, adding to some energy, metals, and agriculture names. I anticipate adding further should investors continue to bail out. As for the financials, I've had no interest in chasing the latest rally. For now, I'm on the sidelines, but should the group rally further, I'll be looking to rebuild a short position in the sector.

My writing is likely to continue to be a little thin over the next couple of weeks since we're in the meat of earnings season. I'm not as effective or coherent a writer when I'm in an earnings release-induced state of catatonia.

Disclosure: The Rubbernecker is long commodities and caffeine and very short sleep.

Google and Gas

“When everyone dislikes something it should be examined. When everyone likes something it should be examined.” -- Confucius

One of the biggest surprises to me from the Google conference call was learning that Google employs a Chief Economist. Had I only been aware of this earlier, I would’ve shorted more shares. I’ve been on many hundreds of conference calls over the years, but I’m having trouble remembering any in which a Chief Economist was one of the presenters. This was often one of the few positive qualities of these calls. Whenever I'd find myself struggling to pay attention to the mindless reading of the press release by the CEO, I'd mutter to myself, "Well, at least I don't have to listen to an economist."

The fact that high-flying, vanquish-all-comers, paradigm-changing Google is the first that I can recall offering up an economist to the investment community seems a bit ironic. This is Google! Shouldn't we be hearing from the Chief Envisioneer of World Domination instead? Perhaps this will be one of those little things we’ll point to in a few years as evidence that the days of heady growth for Google were winding down.

I wrote a critical review of Google's first quarter earnings release back in April when the stock popped from $450 to $540 and all of the analysts were tripping over themselves to see who could capture the most headlines with the biggest price target increase. In my conclusion of that piece, I said that I'd be keeping an eye on the stock and possibly buying put options if the stock kept running.

I didn't buy the put, opting to short the stock instead as increased volatility made put buying a little too expensive. And, unfortunately, I didn't short the stock as it neared $600. The short was initiated last week in the mid-$540s. Even though the stock had already pulled back 10% from its recent high, It was just too tempting. GOOG had held up better than the market during this latest downturn, and it seemed that the entirety of the sell-side community and press were bullish and expecting yet another outstanding googlerific quarter. On top of this, the concerns I shared from last quarter hadn't diminished, and the economy had deteriorated further. It was an appetizing recipe for an earnings disappointment.

Of course, the sell-side was out after the call defending their buy recommendations on Google. I haven't seen one downgrade. AmTech Research is keeping its "Buy" rating but lowering its target from $750 to $725. Cantor keeps their "Buy" and lowers their target from $750 to $675. Kaufman Bros. maintains their "Buy" and lowers their target from $680 to a nice round $657. $657? 57? 7? I mean, c'mon. You feel that confident in your $657 target that you didn't want to round it down 0.304414% to a nice even $655? How can anyone take this supposed precision seriously given the multitude of highly variable factors that go into that target in the first place? Asinine.

The average target price of these three analysts/lemmings implies 40% upside in the stock. The last downgrade I see is a beaut. Jefferies downgraded GOOG from a "Buy" to a "Hold" on February 1, 2008, the very day the company issued disappointing earnings and the stock opened 36 points lower. The downgrade also came one month AFTER the stock fell from a high of over $700 to about $520. See the station? See the train? No? That's because it's already gone. Over the following 5-6 weeks the stock traded as low as $412. When did the analyst upgrade the stock? He waited until April 18th, the day Google reported their "strong" first quarter earnings and the stock opened at $535. It would be difficult to try and time this stock worse.

So what about this quarter's earnings release? As you know by now, EPS came in a bit light, even with the benefit of currency and a nice low tax rate. Unlike the denials in the last conference call, the company finally owned up to being impacted by the slowing economy. They also admitted that the U.K. business was now large enough that seasonality was becoming evident. Paid click growth actually declined sequentially, and revenue growth (one of the concerns I highlighted last quarter) continued to slow.


Growth is clearly the overriding issue here. Huge early market share gains that could mask seasonality and economic weakness are quickly evaporating, which shouldn't be a huge surprise given the scale of GOOG. The question then turns to what the company is worth and what is an attractive stock price. With the stock now trading at about 20x 2009 estimated EPS, I don't find the stock particularly compelling, but I also no longer view it as ridiculously overvalued. Because of this, I covered the short today (Friday). I'll be watching the stock with an open mind from here and would be inclined to fade any substantial move in either direction.

As for the "Gas" part of this piece, since exiting my natural gas position on June 20th I've been patiently sitting on my hands waiting for another crack at it. With this sector and the price of natural gas now down over 20% from their recent highs, my patience has worn thin. I dipped my toe back in on Thursday afternoon, buying one of my favored domestic natural gas E&P names. As usual, the plan is to pump up the position should investors continue to bail out of the sector.

Disclosure: The Rubbernecker is happy to once again have a little gas.

Oil Supply - The Little Engine That Cantarell

Nobody can consistently predict where short-term oil prices are headed because they just can't know what new news is coming or just how trigger-happy the traders will be on any given day. The near-term fundamentals are only slightly less muddy. Clearly we're experiencing some degree of demand destruction as the global economy weakens, people drive less, and alternative energy substitution makes a very small dent. On the other hand, growth in China, Russia, and India is still robust with more and more people in these countries trading in their bicycles and rickshaws for cars every day. It doesn't hurt that Tata Motors is now mass-producing a $2500 car for the Indian market. Also, it was recently reported that the Russian car market is now the largest car market in Europe by sales, with a 41% year-over-year increase in sales in the first 6 months of this year.

As for supply, Saudi Arabia claims to be ramping production, but no independent verification of Saudi oil statistics exists. Aside from the recent large discovery offshore Brazil by Petrobras, there have been no super-major oil discoveries in over 30 years, so it's really difficult to argue that there's a meaningful amount of easy oil left to be found. Demand, of course, has grown steadily over these past few decades while the existing major discoveries from the 1970's and earlier have been gradually depleting. Additionally, who knows when Bush or Ahmadinejad will provide the next school yard shove and again inflame the fears of further Middle East turmoil and possible oil supply disruption.

The largest oil field in the world is the Ghawar field in Saudi Arabia. As mentioned above, no one outside of Saudi Aramco and the royal family really knows the true size of the field or its production trends. There are some prominent voices, most notably Matthew Simmons, who've raised serious questions about the sustainability of production from the field. I highly recommend his book, Twilight in the Desert. Whether or not Ghawar is actually in decline, it would be difficult to argue that the Saudis will be able to sustainably produce at rates much higher than current levels given what anecdotal evidence we do have.

Since we don't have good numbers with which to analyze Ghawar, let's turn to the second and third largest fields. Number 2 on the list is the Burgan field in Kuwait which began producing in 1946. In the fall of 2005, the chairman of the Kuwait Oil Company admitted that the field would only be able to sustain production of 1.7 million barrels of oil per day versus the 2.0 million they had hoped for. It turns out that production above 1.7 million barrels was actually damaging the field. Although production from Burgan may remain flat for many years to come, it certainly seems to have peaked.

Number 3 on the list is the Mexican super-giant, Cantarell, located in the Bay of Campeche in the Gulf of Mexico. The production changes in this field have been dramatic. The field was discovered in 1976 and began producing in 1979. By 1981, the field was already producing 1.16 million barrels per day. 14 years later the field was only producing 1 million barrels per day, and the Mexican government decided to make a major investment to further develop the field. This included drilling new wells, installing new platforms, and constructing the largest nitrogen extraction facility in the world in order to inject nitrogen into the field in order to help "lift" the oil.

The investment seemed to pay off. By 2001, the field was producing 2.2 million barrels of oil per day. By January of 2006 this figure had declined to a still healthy 1.99 million barrels, but the decline has accelerated since then. In December of 2006, production was down to 1.44 million barrels per day. The latest figures for May of 2008 show yet another tremendous decline to 1.04 million barrels per day. Given domestic oil demand growth and faltering supply, the day when Mexico ceases to be an oil exporter seems to be drawing near. (By comparison, some of the largest deepwater fields produce about 250,000 barrels per day, and the average U.S. well produces all of 10.5 barrels per day).

Yes, there is still plenty of oil out there, but the easy oil has largely (not completely) been tapped. Much of the oil that still exists is expensive to reach and produce. Even the recent mammoth discovery by Petrobras will cost untold billions to develop given the depth of water and the total depth at which the field lies. Sustained high oil prices will be necessary to warrant the investment needed to develop these more challenging reserves that exist in the tar sands, the oil shale, the deepwater, and the Arctic. Over time, rising demand and higher exploration and development costs will provide some strong price support to crude.

In the short-term anything can happen. We certainly should expect to see pull-backs, as we've seen over the last couple of days. a 20-30% retracement in the price of oil would hardly be surprising if a near-term production boost (from the Saudis) runs head-on into slackening demand and an easing of tensions with Iran. There are plenty of weak momentum hands in the energy play currently, and it wouldn't take much to shake them out. But with oil becoming more difficult and expensive to extract and with more people in developing countries wanting a piece of the "American dream," the intermediate-term (at least) outlook still remains bullish.

With that in mind, from an investment perspective, I have had and plan to keep a core energy position diversified across a number of favored energy securities and ETFs. When oil and and oil-related shares are sold-off, I'll continue to step in and augment the core position with an eye towards selling this "non-core" addition on the following run. I've been patiently waiting for this next opportunity to buy. Hopefully, George and Mahmoud will keep their mouths shut for a few days, and the sell-off in oil of the last two days will continue and provide the next good entry point. If a strong market rally accompanies this oil sell-off, I may be rebuilding my overall short (not in energy) position soon as well.

Disclosure: The Rubbernecker is long energy-related shares and short rickshaws.

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.

Peak Oil - Bullish News from the Russian Bear

In an article in today's Financial Times, Carola Hoyos and Javier Blas quote a senior executive at Lukoil as stating that Russian oil production has peaked. Some of those refuting the peak oil thesis have been pointing to the vast reserves of Russia as a source of higher future production. It will be important to keep an eye on export data from the large producers over the next few years as their domestic demand continues to increase while supply stagnates.

From the article:

"Leonid Fedun, the 52-year-old vice-president of Lukoil, Russia’s largest independent oil company, told the Financial Times he believed last year’s Russian oil production of about 10m barrels a day was the highest he would see 'in his lifetime'. Russia is the world’s second biggest oil producer.

Mr Fedun compared Russia with the North Sea and Mexico, where oil production is declining dramatically, saying that in the oil-rich region of western Siberia, the mainstay of Russian output, 'the period of intense oil production [growth] is over'.

The Russian government has so far admitted that production growth has stagnated, but has shied away from admitting that post-Soviet output has peaked.

Viktor Khristenko, Russia’s energy minister who is pushing for tax cuts that could stimulate investment, said last week: 'The output level we have today is a plateau, stagnation.'

Russia was until recently considered as the most promising oil region outside the Middle East. Its rapid output growth in the early 2000s helped to meet booming Chinese demand and limited the rise in oil prices."

The trend, however, has turned, with supply dropping below year-ago levels for the first time this decade, according to the International Energy Agency, the energy watchdog."