Defend Yourself and Profit
from the Coming Crude Awakening
A few years back, Whiskey & Gunpowder was one of the few voices predicting a surge in oil prices. Despite analysts’ Pollyanna views, we knew things weren’t what they seemed. So when oil prices shot up from $30 to $49 in just 10 months, most investors were surprised — but Whiskey readers had a chance to rake in enormous profits.
Today, oil is still hovering over $63…but many are wondering if prices have peaked. Is it too late to make money with oil companies? Is it time to take your profits and run?
The answer to both questions is a resounding no!
As dramatic as the run-up as been, it’s nothing compared to what we see coming. Oil companies that have already doubled in price could easily double again…and again!
That’s because the world still doesn’t understand what’s really driving oil prices higher. Most people are still blaming terrorism, global unrest and natural disasters for higher prices at the pump. And while those are all certainly big factors in what you pay at the pump, they’re petty nuisances compared with what will really send prices skyrocketing.
It’s a situation we like to call E-Day — the end of the world’s cheap oil…forever.
For the past several decades, America and the world have benefited from a steady stream of cheap oil. According to the Energy Information Administration, America burns through 20 million barrels of oil a day…and that number shows no sign of slowing down.
But if that source of cheap oil disappears…we’re talking catastrophe.
Farms shut down. Hospitals can’t stay open. Streetlights don’t burn. Trains and trucks don’t run. Planes don’t fly.
In short, without oil, America shuts down.
Americans like to pretend that E-day is pretty far off. But according to my calculations, it’s going to happen much sooner than people think.
Not in a century…not in a decade…not even five years from now.
According to my calculations, E-Day — the day the cheap oil dries up — will be July 2, 2006. If not sooner!
It’s virtually guaranteed…
The New Oil — “Cheap” at $150 a Barrel?!
Take a look the chart on the following page.
Ever since the secret of refining oil was discovered in 1853, we have taken it for granted. There seemed to be no end to the stuff… and it would be a long, long time before we had to worry about using it all.
But then Dr. Marion King Hubbert, a geophysics professor at Columbia University, made an unsettling discovery. While working for Shell in 1956, Hubbert found that oil fields change dramatically as you drain out the oil.
At first, barrels of crude come squirting out of the drill hole. That’s when times are easy. But after years of pumping, pressure disappears. Suddenly, the rest of the oil gets harder and more expensive to draw out.
And when you get to the halfway drainage point — the “peak” — the cost of getting the rest of the oil out skyrockets. Supply enters a permanent downward spiral. And pretty soon, you have to look somewhere else if you don’t want to run out of petroleum.
Hubbert predicted the United States — then the world’s largest oil power — would hit its own devastating oil production peak by the early 1970s.
At the time, America could crank out more oil than any other country in the world. So nobody believed him. In fact, they ridiculed him. And the controversy that followed nearly ruined his career. Shell even hired other geologists willing to put the peak date in 1990 or even 2010.
But it turned out that Hubbert was right. The United States hit its production peak in 1971! Oil wells across Texas and Louisiana started to dry up. Domestic oil production took a downturn and never recovered. Within just three years, gas and oil prices soared…and U.S. oil imports TRIPLED.
OPEC suddenly had an advantage over the United States it had never had before. And the face of oil economics…and oil politics…changed forever.
Hubbert had been right. Many people got wiped out financially during the crisis that followed. But it turns out that that was only the beginning!
Global Oil Production Is Falling Like Dominoes
See, the data Hubbert discovered a full 14 years before the U.S. oil peak didn’t just predict a peak just in the lower 48 states…it also predicted similar peaks for the rest of the world’s petroleum nations…until the entire global oil production would hit a permanent downward slide!
Sure enough, other oil-producing countries have started to fall.
Libya peaked in 1970. Iran peaked in 1974. Romania — once Hitler’s prize petroleum conquest — peaked in 1976. Brunei peaked in 1979. Peru in 1982. Cameroon in 1985. Indonesia peaked in 1997. So did Trinidad.
So far, a total of 51 oil-producing countries have already slammed into a wall of peak oil production. On average for the whole European region, the peak year for oil production was back in 2000! For the whole Asian-Pacific area, it arrived in 2002! And for the former Soviet Union, the oil peak came in 1987!
Shrinking energy supplies ALWAYS mean skyrocketing energy prices, even when the collapse in supply is temporary. What will it mean when that supply collapse is permanent? What will it do to the stock market…to budding small businesses…to the job market…and to the prices of everyday goods?
Many, many people will get caught unaware. However, you could make hundreds of thousands of dollars simply by buying the right energy and resource investments.
Especially if E-Day arrives even sooner than I’m predicting. And it might…because even the countries that still have oil probably have a lot less oil than they’re ready to admit!
Saudi Arabia’s Dying Oil Fields and Shrinking Reserves
When Shell Oil admitted to overestimating its oil reserves by 4.5 billion barrels in 2004, shares plummeted 9% in a single day.
But compared with what the crown princes of Saudi Arabia are doing, Shell Oil’s indiscretion looks like child’s play!
You see, Saudi Arabia claims it won’t hit its oil peak until 2011. Saudi Petroleum Minister Ali Al-Naimi told a Washington, D.C., energy conference that Saudi Arabia’s oil reserves are real…and that there would be “no shortage of oil for at least the next 50 years.”
But don’t count on it!
That’s because the crown jewel of Saudi Arabia’s oil reserves is the Ghawar. In 1948, it held a mind-blowing 87 billion barrels of oil. Then, in the early ‘70s, the world’s top four oil companies — Exxon, Chevron, Texaco and Mobil — estimated there were 60 billion barrels of oil in the Ghawar.
But since then, the Ghawar has churned out 55 billion barrels of crude — meaning it has only 5 billion barrels left.
That’s not 50 years of oil. It’s barely enough to sustain global demand for another THREE WEEKS!
The Saudis know it, too. Every day, they quietly pump 7 million gallons of seawater under the Ghawar oil reservoir just to sustain pumping pressure.
Sure, Saudi Arabia has another 300 oil reservoirs to draw from. But it still gets as much as 90% of the oil it sells from a tiny handful of those reservoirs. The rest have already started to dry up!
And Saudi Arabia isn’t the only OPEC member playing fast and loose with its numbers.
OPEC’s Phantom Oil
In 1986, OPEC made a new rule for its members: You could only export as much oil according to what you had in reserves. Within weeks of the 1986 quota rule, almost every OPEC country “upgraded” its reserves so it could push more oil out the door and rake in more oil revenues for its coffers. But these “upgrades” in reserves came WITHOUT a single new oil well discovery being made…
Of course, you can’t burn “ghost oil.” You can’t hide it forever, either. The world doesn’t have to run out of oil for disaster to strike. The sooner the truth about “ghost oil” is discovered — and the faster real oil supplies fall apart — the sooner E-Day begins!
And when you average together peak production dates for all the major oil producing countries…including Saudi Arabia and the other members of OPEC that have not yet peaked… you get a global production peak smack dab in the middle of 2006.
But that’s just a conservative estimate. In fact, Dr. Kenneth Deffeyes, a Princeton professor and a geophysicist who worked alongside Hubbert in the 1950s, believes E-Day is coming even sooner.
“I’m predicting the smooth curve of oil production will peak on Thanksgiving 2006…the uncertainty is only a few weeks in either direction,” he says.
Is he right? Possibly. Hubbert’s curve predicted years of FLAT oil production at the top of the peak. And for the past several years, says Professor Deffeyes, it HAS been flat.
That means the drastic price hikes for energy will start even earlier than I’m predicting.
“We’ll Pay $182 per Barrel,” Says a White House Insider
Plunging supply and soaring demand…it’s the purest law in economics.
Matthew Simmons is a graduate of the Harvard Business School. Now he’s an investment banker who manages nearly $56 billion in energy investments. He’s been a White House adviser under both Bush and Clinton. And he recently said, “Oil is far too cheap at the moment…the figure I’d use is around $182 a barrel.”
Whiskey & Gunpowder was one of the first investment advisories to predict such a dramatic spike in oil. Now the big-name brokerage houses are jumping on the bandwagon. In late March 2005, Goldman Sachs said oil could easily top $100 a barrel. CIBC’s analysts said the same thing a few weeks later.
While we think those estimates are now a bit low, we completely agree with what such oil prices mean for the world.
MarketWatch says the coming peak oil crisis will “dwarf that of 1973.” The San Francisco Chronicle is calling for “social and economic upheaval across the globe…”
According to the International Energy Agency, global demand in 2004 grew at its fastest pace since 1980. Average global demand is 88.1 million barrels a day. Out of that, about 20 million barrels of daily demand comes from the United States. That’s a hard number to get your head around.
Imagine an Olympic-size swimming pool. Drain the water. Fill it with crude oil. Now do that 9,727 times. Each day of the year. And remember, once it’s burned, it’s gone for good!
No New Oil…and No Renewable Substitutes
The dynamic has completely changed. And why?
Because there hasn’t been a major new oil field discovery in more than 20 years!
Worldwide, net oil discoveries have plunged every five years since 1980. Some of the biggest fields are now between 30–100 years old! And they’re starting to run dry, too!
Worldwide, peak discovery was in the 1950s. No one has discovered a large supply of oil since 2002!
That’s next to nothing compared with world oil demand. Even if we DID find another Ghawar…it would only delay the impact of E-Day by less than 24 months.
You have to ask, if there’s more cheap energy to discover, where is it? Most of the alternative energies — wind, solar, hydroelectric and even hydrogen — will take too long to develop to be in place by 2006.
Consider ethanol, which is a type of fuel that comes from corn. According to David Pimentel, a professor of ecology and agricultural science at Cornell University, 129,600 British thermal units (Btu) of energy are used to produce 1 gallon of ethanol…but a gallon of ethanol provides only 76,000 Btu of energy!
Then there is the ultimate “free fuel,” hydrogen. But here is the rub: Hydrogen is neither cheap nor is it, in the end, environmentally friendly. Dollar for dollar, it costs a hydrogen fuel cell 100 times more to produce the same amount of energy than it costs an internal-combustion engine. Just to be competitive, the cost from fuel cells would have to drop from the current $4 per watt of electricity produced to less than 5 cents.
And while the byproduct of hydrogen energy production is clean water, collecting hydrogen requires vast amounts of conventional energy like coal, oil or natural gas, all of which produce greenhouse gases.
Of course, there are also alternative conventional fuels like coal or nuclear power. Both have reputations as dirty fuels, but technology has come a long way to making them more palatable. But while that’s good news for power plants and electricity, we’re still a long way from using them to power cars, airplanes, etc.
So for now, it’s oil and gas — or nothing. And that means big profits for some oil and gas companies…but probably not the ones you expect.
A Big Name You May Not Know
The problem with many of the big-name oil and gas companies like ExxonMobil or Shell is that their properties are situated all over the world. Sure, they may have the oil, but it’s still going to cost a pretty penny to get it where it needs to go. That’s why we prefer firms that are sitting on big reserves closer to home. Companies like EnCana (ECA: NYSE, ECA: TSE).
The company itself is pretty big — the result of a mega-merger between two Canadian powerhouses, Alberta Energy Company and PanCanadian Energy Corp.
Alberta began its life as an under-publicized oil and gas giant founded in the early 1970s by the Canadian government. In fact, at one point, only Canadian citizens were allowed to buy the stock. Nurtured by a sympathetic government, this once-small company grew into a colossus.
PanCanadian has an interesting history itself. It actually began its life in 1881 as part of the Canadian Pacific Railway (CPR), which was trying to build a transcontinental railway across Canada. Part of its deal with the Canadian government to build the railroad included mineral and surface rights to some of the land it was developing. And when natural gas was discovered on some of those lands, it was off to the races.
CPR eventually made the oil and gas business a separate division. And following CPR’s restructuring in 2001, PanCanadian became an independent, 100% publicly owned company. Just six months later, it announced its agreement to merge with Alberta Energy.
The combined company is now the largest pure exploration and production company in North America. After selling off projects in Ecuador, EnCana was left with 10 key resource projects in the United States and Canada. The company also has exploration projects under way around the world, including in Brazil and the Middle East.
But don’t be fooled — the company’s primary focus is on North America.
The company also has a healthy mix of “midstream” projects — like marketing the oil and gas or just storing the gas. This provides some added income on top of the straight oil sales.
For 2006, the company expects to sell 4,510 million cubic feet of gas equivalent (that is, oil and gas) per day — a 7% jump from 2005’s estimates. The company also replaced 286% of its production. In all, EnCana expects its current fields to continue producing for another nine years at current rates. But don’t worry — it’s also sitting on 18 million undeveloped acres of land.
Still a Value
With so much going for it, it’s no surprise that EnCana led the pack when oil prices took off. Between January and October 2005, the stock more than doubled, before falling back a bit. But that doesn’t mean the stock’s not a value.
For one thing, it’s a better value in terms of price-to-earnings, price-to-sales and price-to-book. Those numbers should hold up if EnCana grows as expected.
But in our mind, what really sets EnCana apart is its deliberate focus on challenging areas, leveraging its knowledge and technical expertise to extract what less skilled competitors overlook or leave behind.
In addition to aggressive expansion in Wyoming, Colorado and Texas, EnCana has big plans for its 485,000 hectares of Canadian oil sands. A few months ago, the company announced its intention to invest $5 billion in oil sands production over time, with a target of 500,000 barrels of production per day by 2015.
So in short, there’s a lot here to love.
Action to take: Buy EnCana (ECA: NYSE).
Speaking of oil sands…
Mining for Oil
As mentioned, EnCana is working to develop oil sands in Canada. Specifically, it’s focused on the Athabasca Oil Sands — the world’s richest deposit, in northern Alberta, Canada.
Until recently, oil sands haven’t received much attention, despite the fact that the world has known about them since Native Americans first settled the land. That’s because they are very different from conventional oil and natural gas deposits.
In conventional deposits, oil and gas are trapped in porous rocks. Drilling into the rock releases the oil and gas, which is then pumped to the surface. Sometimes the fields are under pressure, and oil and gas can be collected at the surface.
But oil sands are different. They are made up of bitumen, a thick, black, asphalt-like oil. Instead of being trapped in porous rock, this bitumen slowly bubbled to the surface, eventually soaking into the silt and sand. Vast fields of oil-soaked sand and clay developed, either at or just below the Earth’s surface. So instead of drilling for the bitumen, you have to mine it. First, layers of overburden — sand, gravel, limestone, sometimes even water — have to be removed from the surface. Then the oil sands themselves have to be dug up and processed.
Until recently, it’s been an expensive proposition. In fact, in 1984, it cost more than $25 to squeeze each barrel of oil from Alberta’s energy sands.
But extraction methods are becoming more efficient and costs are falling. Scientists at Stanford University and research facilities sponsored by the Canadian government have unlocked a powerful new oil extraction technique that is three to four times more efficient than previous methods — dramatically reducing the cost of extracting oil from oil sands.
Today, production costs are hovering below $11 a barrel. And within this decade, technology will provide extraction costs for Alberta’s oil sands equal to or less than the discovery costs of conventional oil in North America.
Oil Sands in Your Backyard
And there’s enough oil to last for a long time. The vastness of the Athabasca Oil Sands is almost impossible to convey in words. The total area covers more than 26,000 square miles, roughly twice the size of Virginia. These oil sands contain 1.7–2.5 trillion barrels of bitumen. From that total, an estimated 300 billion (yes, billion!) barrels of oil are recoverable.
To put the size of this resource into perspective, Alberta’s conventional oil reserves are currently estimated at about 175 billion barrels of oil. Put another way, that is 17 times larger than the most optimistic reserve projections for the Arctic National Wildlife Refuge, and second only to Saudi Arabia.
Since their modest beginnings, Alberta’s oil sands have grown steadily to the point where they now account for more than 30% of Canada’s oil production. And the world is finally starting to notice. In 2002, the U.S. Energy Information Administration boosted its reserve figures for Canada based on the oil sands. Canada’s official petroleum reserves went from 4.9 billion barrels to 180 billion barrels.
That’s more oil than Iraq has. And as extraction techniques continue to evolve, Canada’s oil sands could provide more oil than Saudi Arabia!
Now the race is on to cash in on this rich resource. So far, $23 billion has been spent developing the Athabasca Oil Sands, and projects worth an additional $7 billion are currently under construction.
And while companies like EnCana are rushing to get in on the action, we like one that’s been there the whole time.
A Standout Player
Suncor Energy (SU: NYSE; SU: TSE) is a Canadian integrated energy company that explores, produces and markets crude oil and natural gas. The company was originally formed in 1979 when Sun Co. and Great Canadian Oil Sands merged. It was the first company in the world to open a commercial-scale oil sands facility and pioneered an industry that has made it a world leader in mining and upgrading crude oil from the vast bitumen deposits in Alberta.
Today, Suncor has three principal operating business units: Sunoco, exploration and production and, of course, oil sands. In fact, the oil sands operation represents over 90% of Suncor’s conventional and synthetic crude oil production and accounts for the lion’s share of the company’s asset base, cash flow and earnings.
Suncor also explores, acquires, develops and produces natural gas, a pretty good side business that could get even better if natural gas prices spike again (but that’s a different story). Still, this along with the synthetic operations could make for an explosive price appreciation if the situation in the Middle East becomes even more volatile.
Suncor is also looking for other alternative energies. The company recently got a foothold in the United States, buying a refinery and several retail stations in Colorado from ConocoPhillips. The company invested C$100 million in 2005 to develop an alternative and renewable energy business. The company started a wind power project in Saskatchewan and is building another wind power plant in Alberta. Other projects being considered are hydropower, biomass energy, recovering methane from landfills and the development of solar power.
All well and good…but what we’re really interested in is the oil sands. And 70% of Suncor’s earnings are from its oil sands project in northern Alberta.
Unconventional Profits From Unconventional Oil
On Jan. 4, 2006, the company processed its billionth barrel of oil sands crude since operations began in 1967. That’s a lot of barrels. Suncor President and CEO Rick George sees the achievement as reason to roll up his sleeves: “With our ambitious growth plans, we expect our next billion barrels to be reached much more quickly than the first billion.”
It is easy to be confident when you are breaking production and share price records, as Suncor happens to be doing these days. But the company’s recent performance is even more impressive considering the disaster that struck only one short year ago. Last January, a fire broke out in one of Suncor’s new upgrader units, thanks to a substandard length of pipe that gave out under intense heat conditions. The resulting inferno burned for eight hours; by the time the fire was put out, the entire structure was frozen solid (outside temperatures were more than 30 below zero that time of year). To get inside and examine the scene, Suncor workers literally had to spend weeks chipping the ice away.
The January 2005 fire cut Suncor’s production in half over the nine months that followed. In fact, for the year, the company claimed production of just 171,200 barrels of oil per day. Now in the early days of 2006, Suncor is back to record production levels. A comprehensive insurance policy has also helped, netting hundreds of millions for Suncor in damage claims, with the possibility of recouping hundreds more.
Looking to the future, an upgrade in production capacity (specifically a vacuum unit attached to upgrader 2) has allowed Suncor to move from 225,000 bpd of production previously to 260,000 bpd. This was no small thing, as the upgrade took approximately five years and $425 million to complete. The company’s new goal is to reach 350,000 bpd by 2008, and C$2.5 billion of the 2006 budget will be allocated toward this end. Suncor’s hard-won experience and strength in the face of adversity will serve it well as it works on billion-barrel milestone No. 2.
Keep in mind the biggest advantage Suncor has over its competitors. It doesn’t have to explore for oil. What you see is exactly what you get. It’s all there, and in known quantities. As production costs continue to drop, that difference could be key.
It’s the biggest reason you shouldn’t worry about the company’s record stock price…because we think this ride is just beginning.
Like EnCana, Suncor has some midstream operations of its own. But both are firmly rooted in the exploration and production end of the business. This next recommendation is all downstream.
The Oil-Less Oil Play
Betting on a middleman can be a risky proposition. After all, one of the well-known tactics for a business to save money is to cut out the middleman. Luckily, Valero Energy Corp. (VLO: NYSE) avoids that fate by being the biggest and best at what it does — refining oil.
In fact, Valero is North America’s largest refiner — turning the petroleum that comes out of the ground into usable oil and gasoline. But what makes Valero really stand out is its focus on sour crude oil.
You see, oil comes out of the ground in various conditions. Most refiners prefer to use light, sweet crude oil — that is, oil that contains less sulfur and hydrogen. It’s the easiest and cheapest kind of oil to process. It’s also the oil that’s seeing the most demand…and the most run-ups in price.
Sour crude is cheaper to buy, but it also needs more processing. Valero wasn’t afraid, though. While other refiners chose to stick with sweet crude, Valero built plants to process the sour. Since its refined products from sour crude are virtually identical to every other product out there, Valero has been able to enjoy higher margins.
Valero also has a leg up on the competition in one other area — producing cleaner fuels.
Less Fumes, Bigger Profits
The U.S. Environmental Protection Agency has mandated that the sulfur content of on-road diesel emissions be reduced from the currently allowed 500 parts per million (ppm) to just 15 ppm by the end of 2006.
Valero is ahead of the curve. Near the end of 2002, it became the first refiner in the American Southwest to produce ultra-low sulfur diesel. Not only does the fuel exceed the EPA’s and Texas’ guidelines, it also meets all the specifications for all commercial diesel engines.
Soon after, Valero lined up two major customers for the fuel — including the Dallas Area Rapid Transit (DART) system, the city of Austin and Houston’s Silver Eagle Distributors, the nation’s second-largest distributor of Budweiser beer.
In other words, the company has already spent what it needs to spend… and it has lined up customers to make those investments pay off.
And to see how well it’s been working, all you have to do is look at the bottom line.
A Great Company to Own…and a Great Place to Work
Valero has reported record earnings for 10 consecutive quarters. Its total income for 2005 came in at $3.6 billion — a full 100% higher than in 2004. And that’s after boosting income 190% in 2004.
And those profits are only expected to get stronger…and not just because of higher oil prices. Since 1997, the company has been on an acquisition hunt. It’s brought 14 refineries under its umbrella, taking its production capacity from 170,000 barrels a day to 3.3 million barrels a day.
Another growth area for Valero has been the retail market. In 2002, it acquired 4,100 retail sites — that is, gas stations — that sell Valero products under the names Valero, Diamond Shamrock, Ultramar, Total and Beacon. While these aren’t the focus of Valero’s business, they have helped increase the company’s profits.
Today it has 4,700 in 40 states as well as Latin America, Canada and the Caribbean.
As icing on the cake for its record 2005, Valero was ranked No. 3 on Fortune’s “100 Best Companies to Work For” list, No. 3 on the Forbes “Platinum 400” list, top refiner in the prestigious Platts “Top 250 Global Energy Company” awards list and 17th best energy company ranked by Platts overall. Not a bad haul, especially considering 2005 was the company’s 25th anniversary. CEO Bill Greehey, age 69, handed off the reins to his successor, Bill Klesse, in a growing trend of succession tied to 2006.
Valero is also looking to new possibilities for the future — one possible area of expansion is the building of coke-fueled power plants (coke is a form of solid residue created as a byproduct in the refinery “cracking” process).
As for this year, retiring CEO Greehey believes that Valero’s profit margins in 2006 will match those of 2005 or possibly be even better, due to ongoing tightness of supply and Valero’s built-in market advantages. “I think we’re looking at two or three really great years,” Greehey said. Of course, a company this good doesn’t come cheap. The two-year stock chart rises like a mountain. But despite the stock’s superior run-up, the stock is still a great value. It has a P/E of 10.5 and a P/S of 0.4 — both below the industry averages.
Whatever Valero chooses to do next, this refiner has many bright days ahead of it — and there’s still plenty of growth left. Jump on now to enjoy it!
Action to take: Buy Valero (VLO: NYSE).