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Cheap Oil: RIP

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  • Cheap Oil: RIP

    Cheap Oil: RIP
    By Byron King

    The world is not running out of oil just yet, but it is BEGINNING to run out of oil. The downward slope from "more-than-enough" to "barely enough" could produce wrenching macro-economic adjustments for many nations of the world, including the U.S. But this downward slope will also produce innumerable opportunities for oil-focused investors, especially those investors who focus on the oil services sector.

    Dr. Ali Samsam Bakhtiari of Iran is one of the many leading energy analysts who believe that world oil production "peaked" in 2006. Dr. Bakhtiari believes that the world is now entering a phase of irreversible decline in conventional oil production.

    Depletion is outstripping new discovery and reserve growth, he asserts, and this trend will continue indefinitely. He believes that the world's daily oil output will fall from its present level of about 85 million barrels of oil per day to about 55 million barrels of oil per day by 2020. That is, there will be a 35% decline in available conventional oil within a mere 13 years from now. If he's right, the world will change profoundly.

    But declining oil production does not mean "we are running out of oil." Rather, going forward, oil will become increasingly difficult to locate and extract… and it will become increasingly valuable. But 55 million barrels per day is still one heck of a lot of oil, and life on Earth will go on in some form or another, if the nations of the world do not kill each other while fighting over access to petroleum supplies.

    The point to keep in mind is that from now until long into the future, there will still be oil wells pumping oil from oil fields.

    Yes, that's right, you have to get the oil out of the ground. And when it comes to developing that oil deposit,
    you need oil service companies. Oil service companies provide what the name appears to describe -- drilling
    services, down-hole logging, well completion services and production monitoring.

    So the oil service companies are not in the business of owning -- or even attempting to claim title to -- the oil
    in or coming out of the ground. They make their money providing the services and technical support to the producing entity. Oil service companies, therefore, carry almost no geological or political risk.

    If you own a company that explores for oil, you run the risk of exploration failure. But the oil service company gets paid for performing the services whether the well is a dry hole or not. If you own an oil exploration company, you also run the risk that some hostile or capricious foreign regime will simply steal all or part of your reserves.

    But if the political climate becomes too burdensome, the oil service company can just pull up stakes, exit the unfriendly locale and watch from the sidelines while the bureaucrats mess things up for a few years.

    This is a growing problem. Russia, for example, might browbeat Shell Oil Co. into surrendering most of Shell's share in the Sakhalin-2 project. Or the government of Venezuela might seize control of production facilities from the likes of Chevron or Exxon Mobil. But the "new owners" will still require, say, drill bits from Baker Hughes, wireline services from Schlumberger or well completion services from Halliburton.

    There are many such oil service companies out there, and it almost seems unfair to single out just a few of them, because there are so many good ones. For those of you who want to own an index fund of oil service companies, there are two that I like quite a bit: Oil Services HOLDRs (OIH: AMEX) and the iShares Dow Jones U.S. Oil Equipment Index (IEZ: NYSE).

    The OIH currently holds18 companies, the top four of which are Baker Hughes (BHI), Transocean (RIG), Schlumberger (SLB) and Halliburton (HAL). Together, these four stocks represent about 40% of the OIH portfolio.

    The IEZ index also tracks the performance of the oil equipment and services sector of the U.S. stock market. It includes companies that are suppliers of equipment or services to oil fields and offshore platforms, such as drilling, exploration, engineering, logistics, seismic information services and platform construction. There is a lot of overlap in ownership between these two index funds.

    But if you want to own one or more of the three biggest and best individual companies in the oil service sector, you have to look long and hard at the larger names that provide oil field services to the industry on a global level. The companies to which I refer are Schlumberger (SLB: NYSE), Baker Hughes (BHI: NYSE) and Halliburton (HAL: NYSE). These three companies are considered by many to be the gold standard of the oil service industry.

    Do not make the mistake of thinking that just because these firms are part of the oil business that they are somehow old-fashioned, knuckle-dragging industrial behemoths. All three companies are world leaders in oil field technology, and all of them fund aggressive research and development (R&D) programs. They employ thousands of people with advanced technical degrees, and, overall, keep many patent attorneys and patent examiners busy with their thousands of patent filings every year.

    The oil service sector funds (OIH and IEZ), as well as the specific stocks that I discussed above (SLB, HAL and BHI), have all had significant run-ups in the past two months, as the price of oil recovered from its January lows. Are these stocks "too high to buy" right now? In all candor, this is a close call for me.

    Since I believe that the world crossed the "peak" of conventional oil production in the summer of 2006, I also believe that the long-term price trend for oil is up, up and up Thus, from a long-term view, all of these oil service stocks are still cheap. But over the short-term, anything goes.

    So here is my advice: Start nibbling on these stocks now. But be prepared to pounce and buy aggressively on any general market retreat or pullback. As the rush to find and develop the earth's scarce oil reserves intensifies, the oil services companies are the ones whose numbers will be on the "speed dial" of every major oil exploration company in the world.

    "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx

  • #2
    From what I was reading the other day the effects are already being felt in the poorer countries, and the reason the price has been down a bit is that demand from these countries is already down, they just can't afford it.

    This might slow down demand marginally, but should be an interesting few years coming.
    Find The Trend Whose Premise Is False - Then Bet Against It