By Gene Marcial
Way before the terrorist attacks on September 11 -- and long before Iraq became an obsession for the Bush Administration, oil-industry guru Charles Maxwell had warned that a major shift was developing in the outlook for the world's crude supply and prices: "I am predicting a big change in the 27-year-old pricing range: I see it tilting to the upside," says Maxwell, who publishes and edits an industry newsletter at investment firm Weeden & Co.
Within the period from 2005 to 2007, says Maxwll, "I project the oil volume production growth will flatten, and then go down from there." Since 1974, he notes, the price of oil swung broadly month to month within the range of $10 a barrel to $30. Now he thinks it will rise significantly above $30 -- and stay there.
The industry has a history of consistently overproducing relative to demand, says Maxwell, no matter how hard the world's oil producers tried to restrict supply. Even the energy crunches that occurred through the 1957 Suez Canal crises, 1973 Arab oil embargo, 1980 Iraq-Iran war, and the 1990 Gulf war didn't restrict supply as much as expected in relation to world demand, Maxwell says.
WHAT'S DIFFERENT NOW.
However, this time around, he's convinced that non-OPEC oil production will hit a plateau and then start to decline, pushing the world into a dependence on OPEC for oil supply in a big way, he says. While that would be good news for the oil industry's profitably as crude prices jump from current levels, it would be devastating to economies worldwide.
Why would oil-supply prices rise sharply when they failed to hold to higher levels during past crises? Maxwell believes that several factors operating now weren't previously present in the industry.
One reason, he says, is that a "new-found political unity" is taking hold among the members of OPEC that's quite unprecedented. And Saudi Arabia holds the key, he says, as the holder of the world's largest crude reserves and the OPEC member most able to withhold production. Led by the Saudis, OPEC has recently become determined to cut back production, Maxwell argues, and is now able to create and stick to a more cohesive policy of restricted supply. OPEC's leadership has finally managed to convince members that only if they can hold near to their quota limits, can they embrace a "vision of better days ahead."
Another factor that Maxwell sees driving long-term oil prices higher is the declining world capital investment for exploring for and discovering new oil reserves. He notes that since 1990, capital spending for oil exploration and discovery has dropped precipitously. Although it surged by 32% in 2001, investment fell again in 2002, to almost zero growth, says Maxwell.
Annual increases of 11% to 12% in spending for oil exploration and production are needed to keep supply and demand in balance, according to Maxwell's study. This takes into account volume depletion of about 5.5% a year, demand growth of about 1.5% annually -- along with the effects of rising costs for oil-field services. Maxwell notes that oil volumes being reported by the industry -- adjusted for sales and purchases of reserves -- indicate a paltry gain of 1% for 2003.
Added to all this, of course, is the volatile political and military situation in the Middle East. Should the U.S. decide to launch an attack on Iraq, the price of oil would rocket, figures Maxwell.
So how does an investor deal with this outlook for higher oil prices that would adversely affect such industries as airlines, autos, and the entire manufacturing sector?
The first thing to do, says Maxwell, is to accummulate shares in certain oil stocks. He recommends four oil companies that he says possess "exceptionally long-life hydrocarbon resources in North America," including major operations in the Athabasca tar sands in Alberta, Canada, that hold vast oil reserves (Weeden declined to comment on whether or not it owns these shares).
The four companies are:
Suncor Energy (SU ), a Calgary-based integrated oil company that owns 100% of a profitable oil-sands operatons, currently trading at $15.15 a share, off from its 52-week high of $18.90, reached on May 18, 2002.
EnCana (ECA ), which explores, develops, and produces natural gas and crude oil, mainly in Western Canada. EnCana, which trades at $29.58 a share, isn't far from its 52-week high of $32.96, hit last May. It also produces oil in Ecuador and has discovery operations in Britain's central North Sea.
Petro-Canada (PCZ ), another Canadian oil-and-gas exploration company, is trading at $30 a share, close to its 52-week high of $31.30. Petro-Canada also refines and markets petroluem products and related goods and services.
Imperial Oil (IMO ), which produces and refines natural gas and petroleum products, as well as petrochemicals. Imperial's oil and gas operations are concentrated in Canada and sold under the Esso brand. Its stock trades at $28.35, also not far from its 52-week high of $31.85.
These companies, says Maxwell, possess unusually cheap oil and gas reserves, and trade at reasonable price-earnings ratios -- with high-growth visibilty. Equally exciting, he says, is that they're all potential acquisition candidates for the major U.S. oil companies. And while OPEC may control the levers of oil supply in Maxwell's scenario, these companies couldn't help but benefit from a sharp price rise.
Marcial is BusinessWeek's Inside Wall Street columnist