For Investors: Great 3-Page Article on Oil

Link here.

It was about thirty years ago when an article in Forbes magazine caught my attention that led me to buy shares in Phillips Petroleum, one of the first investment decisions I ever made. I've held those shares all these years and have continued to accumulate even after Phillips and Conoco, Inc., merged (2001) to create the third largest US oil producer at that time.

Now, I see another similar article in Forbes (not that there have not been others in Forbes over the years), and I wish I was thirty years old again. Talk about some great opportunities.

Martin T. Sosnoff has provided a great analysis of where we are likely to go from here.

He falls into the camp that oil is headed for $100/barrel, and as long as the increase is slow and steady, without spikes, it should not lead to undue demand destruction or another recession.

I think it is generally agreed that pricing revolves around OPEC, and by the percentage of the three-page article devoted to OPEC, it appears Mr Sosnoff concurs. (The other factor is the strength of the dollar, which influences the policies of OPEC.)

If so, the first question is whether Saudi Arabia has the reserve capacity to support the demand growth. Some analysts fear that Saudi Arabia has less than three million barrels of reserve capacity; others say Saudi has at least five million barrels of reserve capacity.

According to Sosnoff:

In a demand driven scenario, if OPEC is serious about containing oil prices it must increase production midyear by at least 5 percent. If worldwide GDP grows at 4.5 percent, not 3.5 percent, the Saudi’s spare capacity disappears in under 2 years, assuming they pump it out. Emerging markets, alone, account for all the projected gains in consumption – some 3 million plus barrels over the next 2 years.

It seems to me the world's laggard is the US, and analysts are now saying that US growth should be in the 3.5 to 4.0 range, which suggests to me that worldwide GDP should exceed 4.5.

Sosnoff, again: "... assuming they [the Saudis] pump it out." There are actually three components to that assumption. First, whether Saudi has the ability to pump that much (if there is that much currently available to pump); second, if Saudi has the will (wants) to pump that much; and, 3) whether the global infrastructure can handle that increased production.

The first point: is there that much available to pump? The consensus is yes, but there are plenty of naysayers. The Saudis are now using water injection in their larger fields, suggesting that the fields are significantly depleted compared to the 1950's.

The second point: do the Saudis want to pump more oil? Some Saudis have been on record that they want to stretch their reserves out and are not interested in maximizing production. For their children and grandchildren this is altruistic and magnanimous, but it does place upward pressure on the price of oil, something that is neither altruistic or mangnanimous.

The third point: can the global infrastructure absorb increased capacity. I assume it can. I assume all analysts would argue that infrastructure is not a concern. But I have said a number of times that I'm not so sure. They say there are already tankers full of crude oil streaming slowly to port, slowed down by international agreements. How many empty tankers are there, really? Furthermore, I doubt refining capacity has increased all that much in the past few years. Besides demand destruction due to the global recession of the past couple of years, environmentalists have made it tough on new industrial projects, and, at least for the shareholder, refiners have been losing propositions for the past couple of years. Without refiners, that additional crude oil being pumped by Saudi is not going to do a lot of good. I haven't checked refiner utilization lately, but I know it's been way down, so most folks would argue I am wrong on this. I do remember just before the crash of 2008 (or whenever it was), refining capacity was an issue.

But there is further evidence for concern about the infrastructure: the recent Alaskan pipeline leak and the Enbridge pipeline leak. Of course that had nothing do with OPEC production, but I would assume other companies and other countries are not immune to disruptions in their supply lines due to old systems. I won't even mention political unrest and/or militants disrupting things. Or hurricanes.

But I ramble.

The Forbes/Sosnoff article is one that should be bookmarked and looked at again six months from now and a year from now.

Oh, by the way, for investors, what does Sosnoff like? COP, OXY, SLB, and HAL. All of those companies operate in the Bakken. OXY is a new and very visible player in the Bakken. COP participates through its wholly owned subsidiary, BR. Among other services, SLB and HAL provide fracking services.