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By Martin Hutchinson
Building an oil portfolio is a lot more difficult than it used to be. It was easier 30 years ago, back in the 1970s, when oil prices first rose and people began thinking about how to build portfolios that would take advantage of this “developing” energy sector.
Back then, you could close your eye, stick a pin in the top seven oil companies (the “Seven Sisters”), add a drilling company, a geophysicist, and a couple of speculative plays in Texas or Alberta, and you would have been on easy street.
Had oil prices continued to rise further from their 1981 peak of about $40 per barrel (equivalent to about $90 today) that portfolio would have made you rich. Of course, in the real world, they dropped back, eventually to $10, and you lost your shirt. Probably only the oil majors and maybe the geophysicist were still in business, and they were worth a fraction of their peak value.
These days, even with high oil prices seemingly guaranteed for the foreseeable future, there are problems. The majority of the world’s oil resources are controlled by hostile governments, so it has become very difficult for an investor to get a stake in oil that has yet to be extracted. The oil majors, or their merged successors, are still in business but all of them are having problems replacing depleted reserves.
BP and Shell thought they had cracked the problem by investing in large-scale projects in Russia – Shell to the tune of $20 billion and BP around $15 billion. But both of them have now been forced to sell control to the Russian oil company Gazprom.
ConocoPhillips and others thought they had an innovative solution in Venezuela’s Orinoco tar sands, and together spent $15 billion developing them. But on May 1 Venezuela nationalized its operations. Other companies with attractive projects, under threat of confiscation, have been forced to increase the royalties they pay the local government.
There are two solutions to this. One is to concentrate on the large oil deposits that are located in the countries with more reliable forms of government. But these deposits are often in the form of tar sands or oil shale, and are difficult and expensive to extract.
The second is to focus on the consumers rather than the product, and buy networks of transportation, refinery, and sales outlets serving markets that are rapidly growing.
Oil shale and tar sands are potentially huge sources of long-term oil supply, but they have one important difference: We do not yet know how to extract oil from shale at prices that are competitive in today’s oil market, whereas tar sands can be profitably exploited provided the oil price remains above $40 or so.
Colorado’s oil shale deposits are believed to contain about 1.5 trillion barrels of oil, enough to supply the current U.S. usage for 300 years. Unfortunately, even though people have been trying to extract oil from them for over a century, it still costs about $90-100 a barrel to do so.
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The largest oil shale pilot project in Colorado is that of Shell (NYSE:RDS-B), though Petrobras (NYSE:PZE) has a project in Brazil that is also supplying part of its oil output. However, with either Shell or Petrobras you are not getting a pure oil shale play, and there’s probably not much money to be made unless the price of oil soars beyond $100 and stays there.
In oil sands the two major deposits are Venezuela’s Orinoco tar sands, with 1.8 trillion barrels, and Canada’s Athabasca tar sands, with 1.7 trillion. Again, the total oil deposits in both places are each larger than in the Middle East. Here the extraction costs are larger than regular oil wells, even offshore ones, but you can make money fairly comfortably at $40 per barrel, let alone $60.
In Venezuela, the problem is Hugo Chavez, whose nationalization initiatives have alienated American oil companies. In Canada, there’s Suncor, (NYSE:SU) which does refining and marketing but whose principal operation produces about 270,000 barrels per day from Canadian tar sands. Suncor is a little expensive at 16 times its earnings, but could be quite a nice play if oil prices continue to rise.
Turning now to the markets, the two fastest growing oil markets over the long term are China and India. In China PetroChina (NYSE:PTR) is an integrated oil company like with substantial projects in China itself, but it also looks to have considerable access to the Orinoco development. It seems as though Chavez sees China as a useful anti-U.S. customer.
Be careful though – PetroChina is 88% controlled by the Chinese government, so you’re taking a political risk. Although, I personally prefer China to Russia.
In India, the largest company ONGC is state owned, but you might look at Reliance Industries (OTC:RLNIY). It is India’s largest private-sector oil company (mostly downstream – India’s nowhere near self-sufficiency in oil), though for U.S. investors it has the disadvantage of being quoted on the dreaded Pink Sheets, making it pretty illiquid.
Finally, you might look at the geophysical company Schlumberger (NYSE:SLB). The company does well when oil and gas drilling activity are strong, and they currently are, but beware its 26-time multiple.
In any case, all of these companies would be good, forward-looking prospects with a great deal of potential for profit in today’s slick oil market.
Martin Hutchinson is an advisory panelist for the Money Map Report. He is a former investment banker with 25 years experience in London and New York, former Senior Vice President and Head of Derivatives for Creditanstalt-Bankverein, Director of the Spanish private equity company Gestion Integral de Negocios, advisor to the Korean conglomerate Sunkyong Corporatio,n and U.S. Treasury advisor in Croatia.
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Tags: Oil
