Understand another one of the 5Es: Energy is no longer cheap

We all use Energy for transportation, heating/cooling, and perhaps recreation.   And, at times there is much conversation about Peak Oil and high energy prices.  So we should all be dialed in to the issues and investment themes associated with energy.

Steve Forbes likes to say “ more financial education, and the resulting financial literacy and empowerment, will open our eyes to alternative investment opportunities and be the key to a recovery from this financial crisis.”

In that spirit, I am going to use this article to briefly introduce the Peak Oil concept as part of drilling down (no pun intended) on the Energy theme which is one of the 5 Es of the “5E-valuation framework”.

If we are at Peak Oil what happens next for Energy?

For background information, you can go to my blog for a summary and a pointer to my recent article “Consider using these 5 E-valuation factors to avoid a financial rip tide: learn to thrive, not just survive.”

Here is an excerpt straight from my previous article “1 – Energy is no longer cheap.  We have reached the point of Peak Oil … meaning the easy stuff to find and drill has occurred.  While more oil is being found, it will be very expensive to drill, pump, and distribute to customers so more and more of our budget will be used to pay for energy hence the interest in alternative energy sources and investment opportunities”.

Peak Oil is the easy stuff to find, drill, pump, and transport to customers.  With the easy stuff, we have seen in recent years oil prices that range from the mid teens to approx $150/barrel in 2008.

When we transition to the stuff harder to find, drill, pump, and transport to customers, just image where the prices will go … for sure much higher than the $50-$60-$70 avg price per barrel over the past few years.

Prices for gas at the pump could increase from an avg of $2.50 per gal to way past the $4.50 per gal we experienced in 2008.

If it is twice as hard to get the newer stuff, and everything else stays equal, we could see prices at the pump of $7 – $8 – $9 per gallon.

Many say it was last year’s $4.50 per gal ($150/barrel) that pushed the economy over the cliff and ignited the Great Recession we are now experiencing.

What happens to our economy, and way of life, when costs at the pump increase to the $7 – $8 – $9 per gal area?  It could get ugly … so consider alternative investment opportunities to thrive in a world of more expensive Energy.

Where are we with the “easy stuff?”

Work is underway at existing oil fields (in Saudi Arabia, Mexico, the North Sea, and Nigeria) to coax more oil out of these fields.  Progress is good however every little bit of more effort to get oil out of these fields adds a little bit more to the cost of the barrel of oil.

Many say that there is plenty of oil right now so why be concerned?

There are three reasons:

1)     Demand right now is significantly lower due to the worldwide slow down.  Once we get beyond this crisis, and when economic activity in the new growth areas kick back into gear, demand will skyrocket and quickly consume what many think is “plenty” of oil.

2)     The oil that is plentiful right now is what we see above ground in tankers at sea and storage tanks strategically located around the world.  However there are two other parts of the supply chain that occur prior to this storage activity – one is the exploration/drilling/pumping activity and the other activity is in transportation of oil to customers.  Due to the low cost of oil and lower profits right now, it is not economically feasible at this time to put a whole lot of investment in these two activity areas that occur prior to the storage activity.  If we don’t begin to ramp up investment in these two front end areas, which have 2-5 year lead times, and the demand dramatically increases, prices for the supply in storage, will skyrocket.

3)     Finally, there are two major countries, India and China that are building middle class populations.  Once people in those countries get jobs, one of the first things they want to do is buy a car and drive around.  When this increased mobility kicks-in, the demand for oil & gasoline will skyrocket.

So we need to continue to coax more oil out of existing fields, we need to make and ramp up investments in the first two parts of the supply chain, and we need to find more oil.

Here is a brief status as to the efforts underway to find more oil in 3 locations.

1)     Brazil – recently announced an oil find, the Tupi field, off the east coast of Brazil far out (up to 200 miles) in the Atlantic Ocean that provides reserves (estimated to be about 10 billion barrels) about equal to Saudi Arabia.  It will require wells in waters up to two miles deep and through four – five miles of rock and seabed floor.  Estimates are that $175B will be needed to build and buy dozens of new drill ships and seagoing platforms, along with many dozens of support and servicing vessels.  They will need to lay thousands of miles of pipelines on the seafloor, connecting massive complexes of subsea equipment that will sit atop hundreds of oil wells.  Most likely, it is a five year offshore development effort.  Since the traditional credit markets are not available, the Chinese have arrived to finance much of this effort, in return of course, for oil … which they will need a lot of as their middle class populations grow (as mentioned earlier in this article).

2)     Tiber site in the Gulf of Mexico was announced in early September and is a totally new find and different from the older, more mature fields of Pemex in Cantarell, Mexico.  It is expected to produce over 1 B barrels of oil but it will take many years and a lot of investment dollars (think alternative wealth creating strategies) … plus these wells are likely to be in water at a world record depth of 35,000 feet.  Next steps – it will take approximately two years to confirm and validate scope of potential; design and build an offshore platform at approx $1B; drill wells at $50M each; and approx $500M for an offshore floating facility to offload production storage to tankers.  Sources of financing have not yet been announced.

3)     Namibia – keep going east in the Atlantic from the find offshore of Brazil mentioned above and you will land on the shores of Namibia, a country on the Southwest Coast of Africa (just west of Botswana and just north of the country of South Africa) with a functioning democracy.  This find is in its very early stages and the scope of the find, nor development investment, has been calculated.  However scientists, geologists, and petroleum engineers working the area, are calling it a geologic analog to Brazil’s and expect investment and output to be at least equivalent.  Obviously, much more work is to be done in Namibia.

All of these areas represent significant alternative investment strategies for players, producers, and engineering services.

In previous articles, I wrote that examples of alternative wealth creating strategies included energy assets that are inherently useful like oil rigs … things hard to build, difficult to replace, and costly to substitute … definitely not financial stocks, definitely not retail stocks, definitely not commercial property.

I trust this article provides a little more insight as to why oil rigs, energy, and engineering services companies continue to represent alternative wealth creating strategies.

In addition, a good book to read would be “Twilight in the Desert” by Matthew Simmons.

I will continue to build upon the Energy theme, which is one of the 5 Es of the “5E-valuation framework” and the other Es in the framework (from west to East, Empire is shrinking, Experiment with paper money, and Economic cycle) in future articles and updates at my blog which is at http://aspenIbiz.blogspot.com.