Oil production is peaking, making investing in oil shares ever more attractive.
Remember 9 years ago? Back then 911 referred to a boy band, Chelsea FC were owned by an Englishman, the BBC evening news was at 9 o'clock and the iPod hadn't been invented. Strange times indeed. Stranger still, the entire country was at a standstill. Not because it was glued to the final week of the first Big Brother, but because it had run out of petrol.
Less than a week after protesters first blockaded oil refineries on 8 September 2000, schools were closing down, supermarkets were running out of food and hospitals were cancelling operations. That would never happen if the factories making iPods or plasma TVs were blockaded -- the world would comfortably muddle on without them.
Energy is utterly essential to the way we live; people may grumble about rising fuel prices but they will sacrifice many "luxuries" before they make significant cuts to their energy consumption. In the jargon, oil companies produce something for which demand is somewhat price inelastic. That's always good for investors.
Is oil running out?
Are we running out of oil? Ultimately it is inevitable - on a human timescale it is a finite resource that is being rapidly consumed. The amount of new oil found globally each year has been trending down since the 1960s, and since the 1980s we have not found enough new oil to replace the oil pumped each year.
There's a substantial lag between discovering an oil field and putting it into production, but there is evidence that production is now starting to plateau at around 85 million barrels per day. Some people believe that production has already peaked, others that it might peak in a few years time at maybe 90 million barrels per day but, whoever you believe, increases in oil supply of 20% or more seem unlikely.
The total energy supply will increase thanks to increasing use of nuclear electricity and natural gas among others, and they will encroach on oil use for specific applications. But there's nothing obvious that combines oil's energy density, universality and ease of use; some substitution will happen but it will occur slowly and grudgingly. Again this is good for investors, you're not investing in CDs just as iTunes revolutionises the music business.
Big Western oil companies such as Texaco, Mobil and Gulf Oil were arguably the first "victims" of this peaking in production, they were taken over by stronger rivals as it became ever harder to find the big new fields in friendly countries that they needed just to maintain their production. The fact that the share prices of both BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) are roughly the same now as they were 10 years ago, also suggests that these "majors" are not attractive investments other than as short-term dividend generators.
Learning to share
However those 90 million barrels per day will have to be shared between more and more people. The OECD has about 1.2 billion people consuming just under 15 barrels of oil per year. There are nearly 6 billion people in the rest of the world each consuming just 2.5 barrels of oil per year. Those two numbers will converge.
The populations of countries such as China and Brazil aspire to Western patterns of oil consumption, but in the first instance just want a 5 barrel/year lifestyle, enough for some consumer goods, to transport food to their town and to run a scooter.
If geology constrains production to something around current levels, then every extra barrel of oil consumed in scooters in Shanghai means one less barrel for the Citroens of Sheffield. Whether that barrel of oil ends up in Shanghai or Sheffield will depend on who is prepared to pay the most, and it is this struggle for oil against a background of plateauing production that should broadly underpin oil prices over coming decades.
What's the right price for oil?
Good question. I'll discuss the oil markets in a later article, but I'd say the world needs $60-70 oil to ensure the investment needed to maintain current production and $70-80 oil to support increases in supply.
Certainly $60 oil is a realistic assumption for valuation purposes, and many companies look cheap at that price.
Oil investing - you can do it!
Some investors dismiss the oil sector as too "complicated". I would argue that in some ways it is very simple -- for instance as long as a company can get oil onto a tanker on the high seas, you don't really need to worry about whether someone will buy a company's product or how much a sales force will cost. You don't need a degree in geology, a few basic principles will allow you to evaluate nearly 200 companies on the London markets plus many more overseas.
I'd say that learning those principles is a much more productive use of your time than researching the markets for mobile phones or CCTV cameras, that are relevant to only a handful of listed companies. In coming weeks I will discuss some of those principles, explain some of the jargon used in the industry, and introduce some of the subsectors such as the service companies.
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