A Special Investment Report:
With Crude Oil Prices Still At the Base of a Five-Year Climb, Turn Pain Into Profit
By Jason Simpkins
Just when you thought the global energy outlook couldn’t get any worse …
Worldwide demand for crude oil will continue to outstrip supply for at least the next five years, meaning the high prices and tight supplies of today will remain a reality for the foreseeable future.
The soaring prices of crude oil and gasoline are just part of a broad-based worldwide boom in commodities that is being driven by the full-fledged economic emergence of China, India and some other key markets around the world. Other commodities – as disparate as uranium and fertilizer – have seen big price surges, too. But oil-and-gas prices have grabbed the public’s attention because they affect consumers the most directly. And consumers are right now feeling squeezed.
So, in drawing upon another of those age-old bits of wisdom we’re so fond of here at Money Morning: “If you can’t beat ‘em, join ‘em.” In other words, if this powerful global trend is going to persist – and it is – then you should ease the squeeze on your wallet by profiting along the way.
Let me explain …
Some Crude Estimates
The Paris-based International Energy Agency – advisor to 26 of the world’s industrialized nations – said yesterday that the demand for oil would increase at an average annual rate of 2.2% from this year to 2012. It was only in February that the IEA projected that demand would increase at a 2.0% average annual rate from 2006 to 2011.
It’s not just that the IEA had to revise its demand numbers upward by 10% or add another year to the length of time it expects the ongoing shortage to last. It’s that the IEA had to make these revisions to a worldwide projection less than six months after it did so the first time that underscores the breadth and magnitude of this global oil boom – which is just one of the commodities that are experiencing worldwide bull markets of historic proportions.
Indeed, in another study earlier this year, IEA projected that demand for oil would increase 50% by 2030.
The IEA’s newest forecast, the “Medium-Term Oil Report,” projects that global oil demand will soar from the current 86.1 million barrels per day to 95.8 million bpd in 2011 – representing an average annual increase of 2.2%, and aggregate growth of 11%.
The forecast is based on global economic growth that averages 4.5% annually, and counts on actual increases in global refining capacity falling short of consensus expectations.
Skyrocketing oil prices have been a key worry for months. Crude oil is flirting with the all-time high of $78.65 a barrel – a milestone reached last August – and with momentum so strong, some analysts are looking for $80-a-barrel crude before the year is out.
And now it appears that the worst may be yet to come. In its report, the IEA said that “despite four years of high oil prices, [we see] increasing market tightness beyond 2010.”
The factors influencing the price surge are all well known. While demand in America remains high, demand in developing nations such as China continues to grow at an exorbitant rate. Meanwhile, the effects of a seemingly routine amount of civil unrest in oil producing regions such as Iraq, Iran, and Nigeria remains constant, and the Organization of Petroleum Exporting Countries continues to play its games, refusing to increase production – despite numerous pleas from the IEA
Unfortunately, recent analysis suggests that, if nothing changes, crude oil prices could continue to escalate for at least five years.
As we all learned back in Econ 101, when demand for a product or commodity escalates, so does its price – even if supplies stay unchanged. But tighten those supplies at the same time demand is accelerating…do that, and you’ll see prices ascend vertically.
The report noted that, “A stronger demand outlook, together with project slippage and geopolitical problems has led to downward revisions of OPEC spare capacity by 2 million bpd in 2009.” While the IEA has repeatedly asked that OPEC boost its production, OPEC’s response has been unfailingly negative.
The IEA also cut its forecast for supply from non-OPEC producers by 800,000 bpd in 2011. The unwanted effects of hurricanes ravaging the Gulf Coast, as well as depreciating fields and facilities, have resulted in the slowdown in production of non-OPEC countries.
The bottom line: Oil prices will remain high, and are probably headed even higher. That, in turn, will cause sector stock prices to climb. It will also fuel investments in alternative energy sources, meaning some of those shares can also be expected to climb.
Let’s take a look at some potential investment opportunities …
Oil Plays That Pay
- Big Oil Companies … with shareholder-friendly stock-buyback plans: There are dozens of potential investments in this arena, so we have to look for the companies with “special” qualifications. In this case, that special qualification is that the company must be buying back its own shares. The reason: It’s a little-known fact – but one that’s borne out by scores of academic research studies – that the shares of companies involved in buyback plans tend to outperform the broader market by an annual average of 3.1% a year for the first four years after the buyback is announced.
The two companies that meet this qualification are ConocoPhillips (NYSE: ConocoPhillips, (NYSE: COP) and Royal Dutch Shell PLC (NYSE: RDS.A and NYSE: RDS.B).
ConocoPhillips announced just yesterday that it would buy back as much as $15 billion of its own stock by 2009, a total that includes $2 billion left over from a $4 billion buyback plan announced in February. That’s a testament to the huge amounts of free cash this Houston-based company is generating. And unlike some other companies in the similar situation, ConocoPhillips is putting that cash to use in a shareholder-friendly way. And the company has also shunted aside any concerns about its loss of oil-producing properties in Venezuela, where country President Hugo Chavez nationalized the oil, telecommunications and electricity industries.
In an announcement of its own yesterday, Shell said it had repurchased 390,000 of its “A” shares and another 110,000 of its “B” shares. That makes it a second favorite of ours in Conoco’s class.
- Big Oil companies …which use their core strengths to move into promising related businesses – such as biotechnology.
Our favorite play here is British Petroleum, or BP (NYSE: BP) . BP’s core energy business is going great guns. And it’s also moved into the biotech field and such venues as “custom-engineered bacteria” as part of a broader strategy aimed at attacking the problem of global warming. These biotech-engineered bacteria could be used to help create new kinds of fuels, to increase the efficiency of the production of such fuels as ethanol, and even to make conventional drilling and mining more efficient.
According to recent reports, BP is also investing $500 million over 10 years to finance the Energy Biosciences Institute, or EBI, a specialty lab that’s been proposed for the University of California’s Berkeley campus.
Interestingly, Shell is also a player in such biotech-related initiatives as “bio-refineries,” which are looking for new ways to develop alternative fuels. By using bio-engineered enzymes, companies are developing processes that could transform sugar, wood chips and corn into a gasoline substitute called “cellulosic ethanol.”
Such processes will be vital if alternative fuels are ever to reach the mainstream. Ethanol production has caused corn crop yields to hit records, but even with that explosion in production corn prices had doubled this spring.
- Renewable Energy Funds … money is moving this market. It’s a small group, but its membership is growing as investors become more aware of the push to develop alternative fuels. Many of these funds have already experienced huge gains, so choose carefully, don’t over-invest, and understand that you’re investing for the long haul.
Alternative energy has been a buzzword since the 1970s, when the “alternatives” were nuclear power (fission then and fusion in the future), hydroelectric, geothermal, solar and wind.
Advances in biotechnology are making renewable fuels a reality. And the growing energy demands of the emerging markets are making renewable fuels a necessity.
Renewable energy could provide up to half the nation’s current electricity demand and about 40% of its current fuel needs by 2025, according to a recent study conducted by the American Council on Renewable Energy (ACORE).
And, as readers of Money Morning know very well, liquidity is a key indicator, as well as a key market catalyst. Money has to be flowing into an investment to make it increase in value. And that’s finally happening with renewable energy.
Investors worldwide poured $71 billion of new capital into renewable energy projects in 2006, an increase of 43% from the year before, according to a report the United Nations issued last month. The U.N. forecast said investment would top $85 billion this year. Investments made through the public markets more than doubled to reach $10.3 billion in 2006, while venture-capital investments reached $7.1 billion, the U.N. report stated.
About a fifth of all renewable energy investments were made in the emerging markets, while 9% was made in China, where the heavy reliance on coal has been a cause for global warming worries worldwide.
In the United States, Congress is working on a sweeping renewable energy legislation package.
Biofuels, wind, solar and fuel cells will generate industry wide revenue of $216 billion by 2016 – up from only $56 billion in 2006, according to the industry research firm Clean Edge.
There’s plenty of room for more investments since renewable energy accounts for only about 2% of the world’s electricity generation. But it makes up 18% of the world’s investment in power generation.
And Calvert, the socially-conscious investment firm surveyed nearly 1,100 people and found that about 85% thought that alternative-energy investments were both good for the environment.
Mutual funds include the New Alternatives Fund, while Exchange Traded Funds, or ETFs, include the PowerShares WilderHill Clean Energy Fund (AMEX: PBW) and the PowerShares WilderHill Progressive Energy Portfolio (AMEX: PUW).
There’s also the Market Vectors Global Alternative Energy ETF Trust (NYSE: GEX) .
As we said, invest in these trends for the long haul, and we’re sure you’ll be electrified by the results – or, at least, very pleased.
Money Morning Managing Editor William Patalon III contributed to this report.
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