December 13, 2018

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Where can extra supplies come from?

Where can extra supplies come from?

Ecuador Chevron

Ecuador Chevron

However, it is true that there are increasing geological, commercial and political problems with expanding supply of conventional oil.

The important new discoveries are deep under the oceans, so very expensive to find and exploit. It becomes increasingly difficult for oil majors to operate internationally because of resource nationalism – protection for state oil interests and more aggressive taxation. Nomura recently estimated that seven of the ten top source countries shut out Western oil companies.

The multinationals also face increasingly aggressive competition internationally for access to oil wealth from the China’s three giants: PetroChina, Sinopec and CNOOC, which are still largely state-owned, and have virtually unlimited access to cheap state capital. They are strongly promoted by Beijing to meet the nation’s huge future needs for oil imports and as a better use for trade surpluses than investment in US paper assets.

Longer-term, I expect oil supplies to struggle to keep up with growing demand. The International Energy Agency predicts production will only increase by an average of 0.3 per cent a year over the next quarter-century. But even that assumes discoveries at a much greater growth rate than has been experienced in recent years.

I don’t expect additional energy supplies from unconventionals (tar sands, gas-based liquids) and alternatives (biofuels, battery power) to become large enough to make a significant impact. The long-term uptrend in oil prices is likely to continue. And there is always the risk of a price spike due to some major catastrophe impacting on supply, such as closure of the Hormuz Straits because of a Mideast war.

If you fancy investing in oil, the simplest way is to buy units in one of the exchange-traded funds whose values move in line with the internationally-traded prices of crude. However, technical factors muddy the picture, such as the disparity between the two crude benchmarks, the WTI (sensitive to US demand) and Brent (driven by Asian demand). The disparity is now huge because of a build-up of supply within the US relative to storage capacity.

The direction of the dollar is important, to which crude prices move inversely. When the dollar is strengthening, oil weakens, and vice versa.

If you prefer to invest directly in the shares of oil companies, I find it hard to find any to recommend for a core holding in a portfolio.

The problem with oil firms is that virtually none of them has an impressive earnings growth record. The profits of most of them are driven mainly by the switchback prices of oil itself, rather than the rewards of new discoveries or successful takeovers. They are more like commodity index trackers than corporate growth stocks.

Very few of the majors have delivered sustained earnings growth over the past few years. I reckon the best of the lot are:

• Chevron (ticker: CVX:NYQ) has a respectable 3 per cent dividend yield more than three times covered. It’s the world’s fourth largest oil group by market capitalization, with nearly three-quarters of its earnings originating outside the US. Its foreign interests include a major stake in Nigeria’s offshore fields and in Australia’s giant Gorgon liquefied natural gas venture.
• CNOOC (883:HKG), which of the three Chinese majors is the one most focused on developing offshore China and foreign resources. Its recent production growth has been very strong, and it’s overwhelmingly an oil rather than a gas play. It has overseas interests in Argentina, Indonesia and West Africa, a stake in the world’s first coal-gas-to-liquids project in Australia, and a promising business position in Iraq, with its enormous under-developed resources.
• BG Group (BG:LSE) is a very large global specialist in natural gas (although oil production still accounts for 70 per cent of its value). It’s expensive with a tiny dividend yield and a high price/earnings ratio, but good earnings growth and prospects have made it a stock-market favourite. Its diverse interests encompass the Caribbean, North Africa, the North Sea, coal seam gas in Australia, shale gas in the US and, in particular, a pole position in the deep-water discoveries off Brazil.

Six other oil companies that caught my attention are:

• Premier Oil (PMO:LSE) is a reasonably-valued UK mid-cap with strong earnings growth. It plans to double production to 100,000 barrels a day from its traditional North Sea/onshore UK interests and its more recent focus on Asia, where it has wells or projects coming on stream in Indonesia, Pakistan, India and Vietnam.
• PTT Exploration & Production (PTTEP:SET) is Thailand’s leading oil company, but is rapidly diversifying internationally with interests in Australia, Canada and Burma. It offers a decent 3 per cent dividend yield, 2½ times covered, and plans to triple its current production of 300,000 barrels a day over the next nine years.
• Crescent Point Energy (CPG:TOR) is a speculative play for individual investors. A respected Canadian analyst says this tiny company “does seem to have the best growth and production prospects” in Canada “over the next ten years,” with the best-located reserves in south Saskatchewan. It’s also been paying good, stable dividends.
• China Oilfield Services (2883:HKG) stands to benefit from China’s huge expansion in energy resources irrespective of what happens to oil prices. Although it has a thin dividend, it’s on a cheap PE ratio and has had the strongest earnings growth of all the companies I looked at.

However, I don’t think this is a particularly good time to buy any oil stocks.

Although world oil demand rose by 2.8 million barrels a day last year, that was a rebound from a recession-hit 2008 and 2009, when demand fell by 1.5 million a day. The International Energy Agency is forecasting an increase of only 1.5 million b/d this year. Demand growth in China is expected to halve this year, to about 6 per cent.

Victor Shum, of Singapore-based consultants Purvin & Gertz, suggests that oil prices around $90 to $100 are “not due to supply tightness” as the market is “well-supplied,” with “a lot of inventories, a lot of spare OPEC production capacity.”

OECD oil stocks are currently equivalent to 58 days’ world demand, which is a high level. OPEC, the oil cartel, has the capacity to start pumping extra, up to an extra 5 million barrels a day, equivalent to about 6 per cent of global consumption. That leaves a comfortable cushion to deal with supply shocks. In fact OPEC has already started to supply more.

It was noticeable that when the political crisis in Egypt burst into the news, with speculation both about closure of the Suez pipeline and the longer-term threat to Mideast stability from rising Islamic fundamentalism, oil prices only popped up a few dollars.

All this suggests that recently oil prices have been driven too hard than warranted by fundamentals. One indication of heavy speculation is that record sums have been pouring into US oil futures.

There is potential now for a significant correction in oil, taking prices back into the low 80s or even down into the high 70s.

What could trigger that?

Perhaps political moves in the US to curb speculation in commodities generally, given the impact of rising prices on consumer inflation, especially if oil stays above $100. Perhaps an economic outlook shock in America or China, suggesting there’s going to be an unexpected slowdown in oil demand growth.

At this stage I favour taking some profit out of oil-related investments. Use the time to investigate my recommendations and other oil stocks that interest you, to prepare to buy into this strategic-resources play at lower levels.

Longer-term, I remain confident about oil.

CopyRight – OnTarget February 2011 by Martin Spring

This article follows on from – The Only Viable Major Alternative

which was preceded by – Investing in Liquid Sunshine

The only viable major alternative

The only viable major alternative

Electric Cars

Electric Cars

The current fad is for electric cars, hugely subsidized by governments. How much longer can they afford such subsidies? Besides, the electricity that substitutes for liquid fuels has to be generated. On balance there is no energy benefit relative to oil, and little or no benefit in reducing production of greenhouse gases.

The vehicles will continue to face consumer resistance because of their high cost (even after subsidies) and performance limitations.

I think electric cars do have a future — because of the immense government-driven policies to promote them, improving battery performance, and lower production costs that will come with greater volume. I just don’t think they can be a major alternative to traditional vehicles fuelled by petrol and diesel for the foreseeable future.

The most viable alternative to oil is natural gas.

It is far more abundant in terms of reserves relative to current demand, especially since technological breakthroughs in the US have made it possible to harvest gas from shale and similar previously largely-ignored resources. Huge reserves are also conveniently located in politically-favourable environments, such as America and Australia.

However, production of “tight gas” and shale gas formerly not viable to exploit has transformed the supply situation, halving US prices for natural gas, which have plummeted relative to oil, with which it competes in some uses.

In the US, the Energy Information Administration says its most likely forecast is for the annual average price of gas at the wellhead to remain below $5 per unit for the next decade. This means gas is likely to remain an attractively-priced alternative to oil for years to come. Perhaps. But low gas prices are also discouraging exploration.

Vehicles driven directly by compressed gas have been around a long time. But they haven’t made much of an impact.

Gas only becomes a serious competitor to oil when converted into liquid fuels. Sasol, the South African specialist, has been doing that successfully on a massive scale for half a century as the second stage of converting coal into oil, and is now exporting its expertise to the rest of the world. It is a partner in a Qatar gas-to-liquids project and has just paid $1 billion for a half-share in a Canadian gas-to-liquids venture.

However, the capital and current costs of converting gas to liquids will limit the potential to substitute natural gas for oil, especially as gas is in such strong demand for easier and more direct uses — power generation, heating, petrochemical feedstock.

Oil itself can be recovered from unconventional resources such as the tar sands of Canada and Venezuela. The deposits are enormous, but they are difficult and expensive to recover and process. Canada’s 170 billion barrels are the world’s second largest oil reserves after Saudi-Arabia. Current production is now about 1½ million barrels a day and announced investment plans should nearly double that before the end of the decade.

But opposition from the environment lobby grows stronger by the year. Recovering oil from the sands is a particularly dirty process and processing usually requires a lot of natural gas, which critics say would be better used directly as a clean fuel.

At prices around $100 or more a barrel, many unconventional resources are economic to exploit.

World reserves of conventional oil have risen by 23 per cent over the past decade – partly because of new discoveries such as offshore Brazil and offshore West Africa, but mainly because steady improvements in industry technology has made it possible to harvest commercially a higher proportion of known resources.

That has – so far – discredited the Peak Oil Theory that production would soon top out and then go into decline because there were no more giant new discoveries to be made.

this article is a continuation from – Investing in Liquid Sunshine

and is followed by – Where can extra supplies come from?

CopyRight – OnTarget February 2011 by Martin Spring

Investing in Liquid Sunshine

Oil recently topped $100 a barrel. Does this make investments in it a buy… or a sell?

Oil Pump

Oil Pump

Oil has been in a strong uptrend since early 2009. The main driver has been global economic recovery. But an increasingly important factor has been exploding consumption in emerging economies.

Barclays Capital’s commodities chief, Roger Jones, expects demand from countries outside the OECD, accounting for one third of world oil imports, to grow four times faster this year than those of the group of advanced economies.

The largest of the emerging economies, China, is already the world’s second biggest consumer – using about half as much as the US. On current projections China’s annual demand will exceed America’s in about 15 years’ time – and require an extra 10 million barrels a day, equivalent to the production of, say, five major new oilfields.

Oil provides the liquid fuels that drive the world’s transport system – road vehicles, ships, aircraft. There are no major alternatives. As the global economy grows, so does demand for oil, at an average rate of about 1.4 per cent a year.

But oil is more than that. It is the key to life-quality enhancement. Once a family rises out of poverty, able to afford high-protein foodstuffs and the space and privacy of a decent home, a priority is acquisition of a car. No product of industrialization has done more to transform living standards.

Years ago I described the motor car as the Liberation Machine. “No other invention has done as much to bring personal freedom to the masses. It allows people to travel where they wish, when they wish, without any expense for additional passengers such as children. It adds immeasurably to city-dwellers’ quality of life.”

Nowhere is this happening more dramatically than in China, where every year tens of millions of people see their incomes rise to levels where they can afford the items that mark them as reaching the status of “middle class.”

This year it’s forecast that about 18 million new cars will be sold in China – compared to perhaps 12 million in the US. That means huge additional demand for petrol. Yet car ownership in China relative to population size is still a fraction of America’s. The future potential for vehicle manufacturers – and for the liquid fuels that power them – is mind-blowing.

What are the alternatives to oil?

Most of them are uncompetitive, many of the most promoted requiring huge subsidies that have now become unaffordable for governments whose finances have come under acute stress because of overspending and soggy revenues.

In a new study on the energy outlook for the next 20 years, BP forecasts blistering growth in production of biofuels, forecasting they will account for 30 per cent of the global increase in energy supply.

I cannot believe that. It suggests BP is out-of-touch with political realities, as it showed itself in its Gulf of Mexico crisis last year.

Most biofuels depend on diversion of crops from consumption as foodstuffs to conversion into liquid fuels. That will become politically unacceptable in a world likely to face food shortages. For how much longer, for example, will it be possible for the US to divert 40 per cent of its corn crop into highly-subsidized and protected ethanol manufacture?

In time, it may become commercially viable to make ethanol from waste, or diesel from inedible crops grown on wasteland. But we are still a long way from doing that, or doing so on a large scale.

CopyRight – OnTarget February 2011 by Martin Spring

next article – The only viable major alternative

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