Oil as an Investment for 2009

ScrollFxgreat free widgetsWidgetbox

Business Headlines

Written by Rob Viglione

Friday, 21 November 2008 20:56

by RobViglione

When the market cuts the price of oil in half within three months it is sending a clear signal to producers that there is sufficient capacity to meet global demand for at least the next decade. Well, maybe not. The International Energy Agency (IEA) seems to think that recent price feedback information is exactly the opposite of what is needed to ensure energy needs are met. What does this mean for all of us energy consumers and our portfolios?

Most of the world's oil comes from a few major fields, all of which are old and experiencing declines in output. The days of easy oil may very well be coming to an end, despite the collapse of crude prices this fall. In Twilight in the Desert, Matthew Simmons laboriously analyzes and casts doubt on the Saudi government for obscuring oil reserve data. He postulates that the world's largest fields, particularly those of The Kingdom, will not be able to produce enough supply to match growing future demand.

Global supply and demand estimates by the IEA paint a gloomy scenario. Demand is expected to rise 45 million b/d, going from its present level around 85 million b/d to 106 million b/d by 2030. But the scary thing is that production from the world's major fields is actually decreasing at an annual rate of 6.7 per cent!

My bet is that this will not happen. Prices will have nowhere to go but up to balance increased demand with insufficient supply. The very loose logic:

1. Required investment schedules to meet increased production are lagging. The IEA estimates that in 2007 the world had to invest $450bn to find and develop capacity; only $390bn made it, despite record prices of $147 per barrel. Governments and corporations are drastically scaling back investment now that prices have collapsed. 2. The oil business is becoming increasingly socialized, with an increasing capacity taken from free markets and relegated to governments. Think Russia, Venezuela, Iran, Sudan, and Saudi Arabia, to name a few - these are not free countries with free markets maximizing production. 3. Increasing political risks are driving investment reductions: Think "windfall profits" tax. When companies invest hundreds of billions and lose money shareholders suffer; when they happen to earn a return, government takes it away. This is not a recipe for increased capacity! 4. Most of the world's oil is found in inhospitable climates or political environments. Every few months Nigerian rebels decide to blow up a rig, pipeline, or abduct oil workers. Every few years the Russian government bullies another company out of its investments after they've proven fruitful. The Iranians talk of obliterating Israel. The Sudanese sponsor genocide in Darfur, there's civil war in the Congo, Chavez would love nothing more than to see America collapse, the Bolivians and Ecuadorians nationalized their oil industries, and Russia targets West-flowing pipelines for bombardment whenever it can (think Georgia).

Prices are down in the short term because of a slumping economic outlook. At some point international commerce will recover and we will realize that we have a dire oil problem. When this happens prices will skyrocket. If you lack the risk tolerance to make blatant long bets on price appreciation, at least do yourself a favor and hedge this risk out of your portfolio.

About the Author:

Robert Viglione is an author, hedge fund manager, Realtor, and Humanist. He recently started Viglione & Partners Assurance Group, L.P., SoCal Real Estate Advisors, Inc., and began The Freedom Factory, where you can read more of his wacky writing.