Enjoy low oil prices, because they probably won't last.
It's a cliché, but true nonetheless, that the world runs on oil. Remove the oil and within a few days we'd be back in the Middle Ages, albeit with better teeth (at least for a while).
Investors should be aware that the market for oil is changing; it is becoming much more difficult to produce oil cheaply and this will create some interesting opportunities in the future.
The end of abundance
Over the past decade the price of a barrel of Brent crude oil (34.97 British gallons) has risen from $20 to today's price of about $73. So why has the price of oil risen by so much?
The answer is very simple; the demand for oil is increasing faster than the supply. Oil consumption in developing countries, particularly Brazil, China and India, has increased in recent years due to these countries undergoing industrialisation but the global oil industry has found it difficult to increase production at a similar rate.
The supply situation is going to get worse because the rapid growth in car ownership in these countries means that the demand for oil will continue to increase. In contrast discovering new sources of oil is becoming increasingly difficult/expensive and the production rates of some of the larger oilfields have declined sharply in recent years.
For example, Mexico's Cantarell field produced 2.1 million barrels a day in 2004, second only to Saudi Arabia's giant Ghawar field. Cantarell's production in 2009 was a mere 690,000 barrels a day, a significant drop in global supply when you consider that the world uses some 86.5 million barrels a day.
As most of the cheaply extracted oil has already been discovered the oil companies have turned to remoter parts of the world. Fortunately the high price of oil will make it economical to produce from the more inaccessible regions such as the waters around the Falkland Islands, Greenland and the Arctic Ocean where governments are squabbling over drilling rights.
High oil prices are good
Contrary to the worst case scenarios of some doom mongers the high oil price hasn't trashed the global economy. The major reason for this is that the amount of oil required per unit of economic output has been in steady decline since the mid-1970s after the oil shock of 1973 persuaded manufacturers to make their processes far less oil-dependent.
The best thing that could happen to renewable energy companies, asides from being given even bigger subsidies by the taxpayer, is for the oil price to rise to over $100 a barrel and stay there because at this price the presently uneconomical alternatives (solar, wind, tidal) are quite profitable.
For years this was a major reason why Saudi Arabia acted to depress the oil price; the adoption of renewable energy by their customers is a major threat to their economy. Nowadays it's debatable whether the Saudi's have much spare production capacity (and whether they'd even use it as their economy has become accustomed to getting $60+ a barrel).
Ironically the high level of petrol taxes has sheltered the British consumer from the worst of the rise in oil prices. In contrast American drivers are exposed to the full effects of rising prices, whereas in Britain a doubling of the oil price would cause petrol prices to rise by roughly one-third.
Alternatives to drilling
It might come as a surprise that two countries have bigger oil reserves than Saudi Arabia. Canada and Venezuela have larger reserves once we take if tar sands and shale oil into account.
Now whilst investing in Venezuela is only for the foolhardy, given that state's tendency to confiscate assets from people it doesn't like, investors can safely turn to Canada where companies like Imperial Oil and Suncor Energy are already turning the Athabasca tar sands into oil.
Extracting oil from tar sands is a fairly expensive process, so as oil prices rise this will become vastly much more profitable. Many of the environmental concerns about the tar sands seem like scaremongering to me and I suspect they might vanish should petrol hit £2 a litre.
Another alternative source of oil is to convert coal and/or gas to oil using the Fischer-Troph process, which was developed in Germany in the 1930s and used by the Nazis and Imperial Japan to supplement their wartime oil production. Coal-to-oil isn't just for wartime; the South African company Sasol, best known in Britain for sponsorship of the Springboks rugby team, is to be the biggest producer of oil from coal on the planet.
The world has plenty of unexploited coal reserves, not least in Britain where many unprofitable mines, which were shut down in the 1980s and 1990s, could be brought back into production when prices have become high enough. Companies like UK Coal (LSE: UKC) will then look like a really good investment.
Where else to invest
The oil majors such as BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) aren't as exposed to changes in the oil price as you might think because of their operations throughout the oil supply chain, from exploration and production to refining, distribution and retail.
Instead for exposure to rising oil prices investors should have a look at the medium-sized producers; the Motley Fool hosts two very active discussion boards covering these oil companies here and here, though many of these companies have been bought in recent years as the larger private and state-owned companies have gone "drilling on Wall Street", buying oil companies as an alternative to exploring for oil.
Investors with a strong nerve might consider the very small oil exploration companies where fortunes can be made (and more commonly lost) with a single drilling result. In this sector it's safest to divide your investment between several companies as their share prices can be exceptionally volatile. For example, Victoria Oil & Gas (LSE: VOG) shares are currently 3p having been over 260p back in 2006 whilst Gulf Keystone Petroleum's (LSE: GKP) share price is more than eighteen times what it was in March 2009. Nice when you get it right / are lucky (take your pick!) but horrible when you're wrong!
More from Tony Luckett:
>Tony owns shares in Suncor Energy.
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