Monday, September 19, 2005

Profiting from Peak Oil

A few months ago I spent quite a bit of time doing internet searches trying to find information on mutual funds and investment companies who were aware of Peak Oil and had devised investment vehicles to profit from Peak Oil. At the time I found very little out there. However, in the last month that has begun to change. Now there seem to at plethora of small funds that have picked up on the Peak Oil theme. These include the Guiness-Atkinson Global Energy Fund, Mammoth Resources, Sprott Asset Management, and Raymond James (Canada) Investments.

I believe this is the start of a wave, but right now, some major investment houses (Vanguard for one) are warning investors away from the energy sector. They think that the recent appreciation this sector has seen is unwarranted and speculative. Of course it is only unwarranted if you believe that dramatically lower energy prices are going to return in the near future. If not, then the current valuations are not unwarranted, and in fact, a number of the energy sectors are still priced cheaply relative to the overall market.

So here is what I am going to do for you – my faithful following of readers. I am going to give you Bubba’s own personal investment strategy for Peak Oil. Now I started this last summer, and if you took my advice back then, depending upon how much you invested, you would be a very happy camper, if profiting in the stock market makes you happy. So here is my advice, completely free of charge and conflict of interest, for Peak Oil Investing.

First of all, if you were buying this advice I would say “Caveat Emptor”, but since it is FREE, I will add “use at your own risk”.

I work under the three following premises:

1. From here on into the foreseeable future owners of energy will be the winners. Cash will flow to them. The coming scarcity of oil (and natural gas) will be the rising tide that will carry all energy forms to higher prices (coal, uranium, wind, solar, hydroelectric, bio-mass, etc.). Moreover, owners of long-term supplies of energy (20 or more years) will be much bigger winners than owners of short-term supplies.
2. From here on into the foreseeable future purchasers of energy will be the losers. The more your business or lifestyle depend on the availability of cheap energy, the more you will be hurt from here on out (airlines, car companies, chemical companies, home builders who build in the suburbs, road construction companies, entertainment companies like casinos or Disney, etc.)
3. There is a time coming when cash will be very important to your financial well being. You won’t know when that time will be until it arrives. Don’t be caught without a significant portion of your assets in cash.

Here’s how I apply the above premises to investing.

For everybody

1. Keep lots of cash on hand.
2. Stay out of the broad based mutual funds and overall stock market
3. Keep your household debt down to a minimum, especially if you work in one of the companies that will be hurt by rising energy costs
4. Get rid of that gas-guzzling SUV or truck.
5. Avoid buying that big house that you love 40 miles from your work.

For those with a moderate (to high) risk tolerance

Invest in those companies who OWN long-lived energy stockpiles and hold for the long term

1. Canadian Oil Sand Companies
2. North American Coal Companies
3. Oil and Gas Companies that have long lived reserves
4. Other energy companies positioned to profit from high energy prices

For those with extreme risk tolerance (aka Huge Balls)

Short Sell

American automobile companies
Home builders
Resort Hotels
And lots of others

Let’s focus on the middle category for now, because that is the one I find myself in and the one I know the most about.

Most energy companies, with few exceptions, have seen their stock valuations skyrocket in the past 2 to 2.5 years. This, of course, is tied to the rising price of oil. So we have seen oil company stocks rise, but we have also seen coal company stocks, uranium mining stocks, gas-to-liquid stocks, and oil refining stocks rise.

Of course, as with everything in life, some of these companies have done better than others. If you would have bought 10,000 shares UTS Energy Corp. for $0.60/shr (total investment of $6000) last summer when I first recommended it, you would be sitting on a gain of nearly $40,000. A similar investment in ExxonMobil would have resulted in a gain of less than $2000. So why would that be?

ExxonMobil, the largest energy company on the planet, with the largest reserve base, is a behemoth. It may own more oil and gas than any other publicly traded company, but it sells a lot of that stuff every day. In fact it sells so much oil and gas that it has to work like hell to try to replace the oil it sells every year. This is true for all major oil companies, and the fact of the matter is that they are not doing a very good job of replacing into their reserve inventories the amount of oil they sell every year. Those of us who believe in Peak Oil think it is increasingly unlikely that companies like Exxon and Shell will be able to continue to replace their in-ground inventories of oil and gas. When this happens, they will just be liquidating their assets and going out of business. This is the signal that I think the market is sending about these multi-national oil companies.

UTS, on the other hand, was sitting on 2.8 billion barrels of undeveloped bitumen in a prime area in the middle of the Athabasca Tar Sands development. Last summer they did not have a way to commercialize this resource. However, since then they brought in two partners (PetroCanada and Teck Cominco) with considerable war chests, expertise, and commercial gravitas. These partners have agreed to pay almost all of the multi-billion dollar initial investment required to get this project off the ground. So now UTS is sitting on 25% of 2.8 billion barrels heading toward development without any initial capital exposure to UTS itself, rather than sitting on 100% of 2.8 billion barrels sitting in the ground and heading nowhere. The stock market has approved strongly of these measures and early investors are sitting on a pile of cash.

I guess this post could go on and on, but I think that most people reading this are really interested in recommendations – so here they are:

Tar Sand Companies – Own and hold them all. If you believe that oil is cheaply priced at $60/bbl you should buy these. If you believe it is overpriced at $50/bbl you should not, as most are probably priced in the market as if $50 oil is here to stay.
Canadian Oil Sands Trust
Imperial Oil
Shell Canada
Canadian Natural Resources
UTS Energy
Western Oil Sands
OPTI Canada

Oil and Gas Producers

Focus on those companies that have long lived reserves. This is measured by the ratio of their reserves divided by their production (R/P). Also, focus on companies with heavy upstream exposure compared to other sectors. Lastly, pay attention to the P/E ratio.

The companies I like are:

Husky Energy

Coal Companies

Focus on those companies that have long lived reserves. A number of coal producers are organized as partnerships, which makes for complicated tax accounting. For this reason, I keep these in my IRA so I don’t have to worry about the immediate tax consequences. Also, I am somewhat leary about niche players. The companies that are producing metallurgical quality coal are getting a significant premium, both in revenue per ton sold and share price, to more run of the mill producers. I wonder, however, if steel production takes a hit whether this premium will mostly evaporate.

The companies I like are:

Peabody Energy
Alliance Resource Partners
Natural Resource Partners
Consolidated Natural Resources
Massey Energy
Fording Canadian Coal Trust


Sasol – South African gas to liquids company
Comeco – Canadian-based Uranium mining company

What about alternative energy companies, you ask? Wind power, solar energy, geothermal, biomass, biodiesel? I am convinced there will be major winners and losers in the alternative energy category. I just don’t know how to pick the winners. You can’t own the sun, and you can’t own the wind. If you come up with the best wind turbine or most efficient solar cell who is to prevent the next guy to trumping your design a year later? It is just too easy, as an investor, to invest in the wrong good idea.

OK, so there you have it. All these companies have profited tremendously from the run up in oil prices. Will they continue to go higher? Over the long term this is a good bet, but not necessarily over the short term. As I said earlier – use this advice at your own risk.

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