Fossil Fuels - Energy and Capital

When To Invest in Oil

We're at a critical junction for oil prices.

If oil prices continue falling, we're going to be right back where we started. More projects will be shelved and future supply will be put on hold. We'll simply end up with another supply crunch from the lack of new investment.

And right now, we're staring at a huge buying opportunity for investors, but I'll get to that in a bit.

I simply can't see oil prices falling below $60 per barrel for very long (assuming the latest sell off drives prices that low). The reason? For starters, hindering new supply much longer will only lead to another crunch.

Let's be honest, the cheap, easy-to-get oil is nearly gone. Even the mighty Ghawar field looks more like a gigantic wishing well, considering the amount of seawater they're pumping into it.

Unfortunately,the U.S. can't afford to wait around much longer. If you haven't noticed, our domestic production has been spiraling down the drain lately. And last year turned out to be quite a year for U.S. oil production.

In fact, last year our domestic production fell below 5 million barrels per day (4.95 million barrels per day, according to the EIA). The last time our production fell below that mark was in 1946. If you don't want to take my word for it, check it out for yourself. Meanwhile, our consumption levels grew to more than 20 million barrels per day.

Understandably, much of that production loss can be attributed to oil prices' collapsing to $30 per barrel in 2008. However, that price collapse took its toll. Companies across the board were forced to slash drilling budgets.

According to oil-field services company Baker Hughes, there are approximately 908 rigs drilling for oil and gas across the U.S. To put that into perspective, there were over 1600 rigs operating last September.

But the problem isn't just our declining production. Remember, the U.S. is importing approximately three-quarters of our demand. Nearly half of our imported oil comes from various OPEC countries (Canada remains the leading source, but our addiction is still mostly dependent on OPEC as a whole).

And trust me, OPEC knows exactly how valuable their crude is to the market. . .

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OPEC Oil Production

If you need any more convincing, look no further than Iraq.

The latest round of bidding to develop several of Iraq's oil fields ended up in disappointment. Due to tough pricing (set at $2 per-barrel payout for new production), only one bid was awarded. Trust me, Iraq's oil ministry knows how important their oil will be to future supply.

Although the first round of auctions only resulted in one successful bid, another round is slated for later this year. This time, oil execs will have some time to think the terms over, and I have a feeling we'll see more than one bid. We know Iraq's fields will eventually be developed. They're simply too good to pass up.

The last time I talked about OPEC, prices were pushing higher, and the Saudis were calling for $75 a barrel. That was last March. Oil prices nearly hit that mark, reaching as high as $73.90 per barrel nearly a month ago.

Don't hold your breath waiting for OPEC to boost their production. Even with the latest sell-off, I wouldn't expect OPEC to open the taps suddenly.

As if on cue, Kuwait reiterated that fact on Sunday, stating oil prices won't go below $60 per barrel. So, if $60 is the bottom, how much is too much?

According to the same Kuwaiti oil minister, $100 per barrel would hurt the world's economy. However, he was quick to point out that even $100 per barrel would not lead to an increase in OPEC production.

If we don't see oil prices rebound within the next week, expect OPEC to continue warning us on the danger of future production.

Assuming the world's economy eventually gets its act together, we'll begin to see demand rise. In their latest Medium-Term Oil Market Report, the IEA projected global demand will reach 89 million barrels per day within the next five years.

The times, dear reader, they are a-changing.

Is This the Next Buying Opportunity?

So, where does that leave us?

Like I mentioned before, we're staring at another buying opportunity. Even if oil prices were to fall below $60 per barrel (currently trading higher at $64.56 a barrel this morning), it won't be for very long.

And the next rebound in prices will certainly boost those undervalued stocks that have been unfairly beaten down. For example, if you had told me a few months ago that I could buy my favorite offshore drillers at this much of a discount, I wouldn't hesitate for a second. A lot of those companies have been extremely oversold lately, and most of my readers are on the verge of picking up more.

As we move towards the backside of Hubbert's peak, things are going to be a lot different.

And one simple fact remains: in order to keep new supply flowing, oil prices cannot fall much lower. Every day oil trades under $60 a barrel (some argue $70-$80 a barrel) will only cause problems bringing new supply online.

I believe we're going to see oil prices move higher, making today the next buying opportunity.

Anyone care to take me up on that bet?

Until next time,

Keith Kohl

Editor's Note: Recently, my colleague, Brian Hicks, uncovered an economic catch-22 in the oil markets that will make investors a tidy profit off the next oil price rally. In fact, many of my readers have already made a small fortune from oil's first run to $75 per barrel. And I would be remiss if I didn't offer all my Energy & Capital readers the same chance to make those gains. Click here to read the full report on this quick money-making opportunity.

The Oil Sands of Alberta Canada

Things were much different when I made my 40-hour trek to Alberta's oil sands.

At the time, oil prices were passing $70/bbl and on their way to $100 a barrel. I absolutely had to see the massive oil sands operations in Fort McMurray.

Can you blame me?

Production from the oil sands is one of the reasons why Canada remains the largest source of oil for the U.S. The sky was the limit for Alberta as oil made its run to $147 per barrel. And it wasn't just the U.S. that had its sights set on oil sands production. I distinctly remember how all the signs in our hotel were written in both English and Chinese.

What a difference a year can make. As I'm sure you know, Alberta was hit extremely hard when oil prices collapsed to $30 per barrel in late 2008. Once oil prices fell below $40 per barrel, I was told time and again it was the end for Canada's oil sands.

I didn't buy it.

The fact is they've been producing oil there for decades. I knew if these companies were able to keep running when oil was much cheaper during the early 1980s, they would survive 2008's price shock.

Sure enough, oil prices managed to rebound in 2009. Now we're back at $70/bbl oil, and I think we're about to see another revival in oil sands production. However, this revival won't be focused on the massive mining operations that give the oil sands their dirty reputation. Furthermore, the next generation of the oil sands could make investors a small fortune.

I'll get to that in just a moment.

Canada's Alberta Oil Sands

It's no secret Alberta has had its fair share of trouble. When Alberta announced its 20% royalty hike a few years ago, companies started to look for better opportunities elsewhere. With the huge potential of the Bakken play in southeastern Saskatchewan, companies soon flocked to Alberta's neighboring province.

Recently, Alberta fought back, revising its royalty program (for the fifth time since 2007) in order to boost drilling activity. The Alberta government recently extended two drilling incentive programs to March 2011.

That's a start. But let's get back to the oil sands. . .

A few weeks ago, I found myself in a heated debate over the future of the oil sands. And one thing soon became clear to me: this gentleman knew absolutely nothing about where oil sands production was headed. All he could focus on was how the dirty tar sands were plaguing the environment. Hence, the oil sands were an abomination that must be stopped.

To a certain extent, he was right. The massive surface mining operations involve an energy-intensive process that leaves a huge environmental footprint. Granted, he wasn't aware of the reclamation projects underway.

The problem, however, was that he knew practically nothing about oil sands extraction. If he were a little better informed, then he might have been able to see the oil sands in a different light.

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For starters, only about 20% of the entire oil sands resource is too deep to be mined. And that, dear reader, is the key to realizing its potential.

You see, the next generation in oil sands extraction is not with those surface mining pits, but rather using in-situ methods like SAGD (Steam Assisted Gravity Drainage). In SAGD, steam is injected into a deposit in order to heat up the thick bitumen. Lowering the bitumen's viscosity will allow it to flow towards producing wells.

I wouldn't be so quick to lump these in-situ methods in with those devastating surface mining operations. In fact, in-situ operations leave approximately the same environmental footprint as conventional operations (not to mention they use 20% less water than the mining projects).

Now, that's not to say there aren't still obstacles to overcome. The SAGD method, for example, emits more greenhouse gases per barrel than mining and is still an energy-intensive project.

Naturally, there are more in-situ methods being developed for commercial production. Petrobank's THAI process immediately comes to mind, which involves a fire flood underground and upgrading the bitumen underground. The THAI process is projected to recover between 70-80% of the oil-in-place, compared to the 20-50% recovery from current in-situ methods. Furthermore, the THAI process uses a negligible amount of natural gas and water.

Considering 97% of Canada's oil reserves come from the oil sands, I think it's safe to assume development will continue. Unless, of course, you'd like to see our dependence on OPEC oil rise.

Need more proof of an oil sands revival?

Look no further than Section 526. . .

Section 526

Section 526 of the Energy Independence and Security Act of 2007 had some strong implications for the Canadian oil sands. Section 526 targeted unconventional petroleum sources with greenhouse gas emissions greater than conventional sources. In other words, Section 526 prohibits the government from purchasing fuels with a higher carbon intensity than gasoline.

On June 17, the U.S. Senate Energy and Natural Resources Committee voted for a bill that could put the oil sands back in our good graces. One amendment passed by a voice vote stated U.S. refiners would not be in violation of Section 526 by buying crude oil produced from Canadian oil sands.

With oil prices on their way to $80 per barrel, any weakening of Section 526 will undoubtedly boost oil sands activity. And I expect those smaller companies developing new in-situ recovery methods will come out on top in the next round of oil sands' profits.

Until next time,

Keith Kohl

Energy and Capital

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The Facts on Methane Gas Hydrates

"Are gas hydrates the answer to our energy problems?"

You'd be surprised how many times I was asked this question over the weekend. It started with a few emails that began trickling into my inbox. By the time I was able to respond, the floodgates had opened. Considering that gas hydrates have been making headlines recently, I should have seen it coming.

It's not often you find me this skeptical over a new source of energy. I would even bet a few of you thought I was headed on another tirade against LNG. I've always been clear to my readers about my concerns over liquefied natural gas.

Not much has changed. I still think it is nothing more than a sinkhole for your hard-earned money, but we'll save that argument for another time.

To be honest, the first thing that comes to mind about gas hydrates has nothing to do with natural gas. Instead, it was the Green River oil shales.

Think about it for a second. . .

Here we have two massive deposits of oil and natural gas that may never be commercially developed.

The problem in both cases is the lack of technology necessary to develop these resources. A best-case scenario would still mean we're decades away from commercial production. That date is pushed further back when you consider how far oil and natural gas prices plunged since last July.

For the sake of anyone still scratching their heads in confusion, here's a brief rundown of the situation.

Gas Hydrates

It's been nearly three years since I last mentioned the possibility of developing methane gas hydrates.

At the time, I had said "The current state of methane hydrate technology appears very disheartening, and production from these hydrates is more suitable in science fiction."

So what exactly are gas hydrates?

According to the USGS, gas hydrates are a crystalline solid consisting of a gas molecule surrounded by a cage of water molecules. These hydrates are found in ocean-floor sediments at depths of more than 500 meters. The gas hydrates are able to form under the cold temperatures and high pressures found on the ocean floor.

In other words, we're talking about chunks of methane-filled ice that scientists are able to collect.

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And even though the amount of methane gas hydrates can't be pinpointed, the higher estimates suggest there are more than ten times the amount of gas hydrates than currently known reserves for conventional natural gas.

Not too shabby.

And as I mentioned earlier, methane gas hydrates have been making the headlines lately. . .

The Ice that Burns

Last November, a U.S. research team reported that approximately 85.4 trillion cubic feet of natural gas could be potentially recovered from gas hydrates located in Alaska's Northern Slope. Remember, that's how much can be developed and produced.

Don't confuse this number with the 1995 USGS assessment, which came out with a staggering 590 trillion cubic feet of natural gas. The 1995 estimate was an assessment of "all volumes of gas" rather than what could be technically recoverable gas.

To put that in perspective, the world uses approximately 100 trillion cubic feet of natural gas per year, and the U.S. consumes nearly a fifth of that amount—a little over 20 trillion cubic feet of natural gas per year.

Another recent development came from the Gulf of Mexico. Several drillers announced that they had found large deposit of methane gas hydrates on the floor of the Gulf of Mexico.

Of course, there's a catch when it comes to gas hydrates, and a very specific reason why I can't too excited over its potential.

Gas Hydrates: Wishful Thinking or Future Production

Right now, developing the world's deposits of gas hydrates seem like nothing more than a bit of wishful thinking.

For starters, the technology is to commercially produce gas hydrates may be decades away. Personally, I can think of much more profitable plays for natural gas investments.

The emergence of prospective shale basins over the last several years is too difficult to ignore. Now factor in the new advances made in horizontal drilling and hydraulic fracturing techniques. I know these shale plays aren't new to my readers. More importantly, we're able to bring that production to market, unlike the methane ice lying at the bottom of the ocean.

It makes sense the U.S. would develop those unconventional onshore fields before extracting gas hydrates off the ocean floor. Also imagine how many more advancements those shale drillers will make by the time we're technologically proficient enough to commercially recover gas hydrates.

While the development of gas hydrates may be only a matter of time (a long time, in this case), there are simply better opportunities out there available for investors.

Until next time,

Keith Kohl

Energy and Capital

Editor's Note: Let's be honest with ourselves, do we really want to wait around for decades while scientists try and develop the technology needed to commercially produce gas hydrates? I didn't think so. But my colleague, Ian Cooper, has been taking advantage of a perfect storm developing in the energy market. I suggest you take a look at these profits for yourself.

2009 Crude Oil Forecast

It's only a matter of time. . .

Even as oil dips below $70 per barrel, I wonder how long it will be until crude is trading back in triple digits.

Yes, you read that correctly.

And quite frankly, I have a feeling many of you agree oil will move that high in the long run. Understandably, there are a few dissenters. I can remember a particularly vicious email from a gentleman who was certain oil would remain below $50 per barrel for at least another five years.

I couldn't help but laugh at the idea.

For the sake of decency, I'll spare you the expletives he used to justify his prediction. And as you know, things turned out a little differently than my disgruntled friend believed. I'll bet those of you (like myself) who felt oil was sorely undervalued at $40 per barrel have done quite well since early March.

Lately, there have been a number of predictions tossed back and forth. Take the latest forecast by Goldman Sachs — they're calling for oil prices to rise to $85 per barrel by the end of 2009, with tighter fundamentals and an economic recovery as the driving forces. They're betting OPEC will cut output and lower supply.

Toss in some good news on an economic recovery, and oil's climbing to $85 a barrel is certainly a possibility.

If that's the case, where will that put us? Well, I'll put it this way — every day that oil trades lower is another opportunity for investors take advantage and post some solid gains.

But before I get into that, let's quickly go over why oil's price may be headed back to triple digits. . .

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Crude Oil Forecast

Although the U.S. is the undisputed king of oil consumption, don't take your eyes off of China. In fact, if things continue the way they have been, China will take our oil guzzling crown as early as 2014.

Last week, China reported its industrial production grew 8.9% last month compared to a year ago. The news had two immediate effects. . .

For starters, the news was enough to help push crude oil as high as $73.23 a barrel during trading last week. Furthermore, the industrial growth also led the IEA to revise its global demand forecast.

For the record, that's the IEA's first demand projection increase since last August. Their monthly oil report expects global demand to fall by 2.47 million barrels per day (their previous estimate was a 2.56 million barrel decline).

If the IEA report isn't enough to make you believe demand is back on the rise, also take the Energy Information Administration's (EIA) weekly oil report under consideration.

A week ago, the EIA reported a 4.4 million barrel draw on U.S. crude oil stocks. Last Tuesday, the administration released its Short-Term Energy Outlook, which stated that U.S. motor gasoline demand will increase by 30,000 barrels per day due to lower prices. Also, the EIA reported that an economic recovery in 2010 will lead to a 300,000 bbl/day increase in total liquid fuel consumption.

And then we get to OPEC. . .

The Next Oil Price Spike

Recently, Saudi Arabia reiterated that problems still persist in the oil markets and pointed out that a barrel of oil is still less than half the price from last July's record of $147 per barrel.

Even though oil is still trying to find support at $70 a barrel, the Saudis still insist future investments are in danger. Their state-run oil company, Saudi Aramco, said 2008's oil price collapse was merely "a temporary phenomenon."

They went even further, saying, "If others do not begin to invest similarly in new capacity expansion projects, we could see within two to three years another price spike similar to, or worse than, what we witnessed in 2008."

For once, I'm inclined to agree with the Saudis.

Depending on demand growth over the next 12 months, I think $100 per barrel is within reason. As for further OPEC production cutbacks, I'd like to hear their next 'comfort level' price for oil. If crude prices rise over $80 per barrel, I wouldn't be surprised if OPEC suddenly felt that $90 per barrel was acceptable.

But let's get back to another matter at hand. . .

What will another oil price spike mean for us? Well, as you might expect, another run for oil will open the door wide for investors.

Going Long on Oil

It's no secret many of my readers have been raking in huge gains since early March. I'd say it has been a pleasant ride for some of us.

Last Friday, investors began taking some of their profits off the table. And for the most part, I can understand their reasons. Oil finally broke $70 per barrel and is looking for support. The latest round of selling was due.

Trust me, dear reader, taking a gain is never a wrong move, especially in today's market. And if you've waited on the sidelines, I can only hope you're on board for the next run. Like I said earlier, the door is wide open right now. Next week, I'll show you my five favorite oil companies worth picking up before oil makes a climb over $80 a barrel.

Until next time,

Keith Kohl

Energy and Capital

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Arctic Oil and Gas Challenges

Last week, I summarized the new USGS report on the undiscovered oil and gas resources of the Arctic. This week, I'll share with you what I learned at the OTC 2009 conference last month about some of the challenges the industry faces in developing those resources.

Arctic drilling is not new. The first successful well was drilled in March 1968, when ARCO struck oil in the Prudhoe Bay field 250 miles north of the Arctic Circle on the North Slope of Alaska, near the Arctic Ocean. The find was the largest oil field in the U.S., with an estimated 13 billion barrels of recoverable oil (BP), twice the total reserves of the East Texas field, and a flow rate of around 400,000 barrels per day (EIA).

The discovery kicked off an exploration spree throughout the Arctic. By the mid-1970s, offshore drilling was under way as well, but offshore production in the Arctic and sub-Arctic has remained limited due to its difficulty. A mere two million barrels of oil, and no gas, have been produced from the Canadian Arctic offshore since 1985.

ConocoPhillips (NYSE: COP) is the second largest Arctic producer after Russia's Gazprom. Peter Noble, the Chief Naval Architect for ConocoPhillips, ticked off some of the main challenges to Arctic production at the OTC conference.

To begin with, the drillships used in the 70s and 80s are no more. The US hasn't built new icebreakers since the 1970s under Nixon. With a renewed interest in the Arctic, the oil and gas industry is now designing and building a new class of modern drillships and tankers for the Arctic, able to penetrate deeper waters and deeper reservoirs, and break ice continuously. These are highly specialized ships, made by manufacturers such as Finland's Wärtsilä Corporation (HEL:WRTBV).

Submersible drilling rigs can be used in the Arctic, but they can only be moved in open water season, and work best in water depths of less than 30 meters (most of the new prospects in the Arctic are in depths up to 1000 meters). Harsh environment semi-submersibles exist, but none are really capable of surviving months of being locked in ice.

Similarly, collecting 3-D seismic data in 600 to 1000 meters of water today is a much more difficult task than shooting 2-D seismic in 30 meters of water was in the 1980s.

What we need to keep going, said Noble, is drilling solutions that can operate in more than "tens of days" in the warm season. Year-round transportation is needed, instead of platforms being inaccessible to tankers for most of the year, while offshore platforms keep pumping into large and expensive storage tanks.

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Beyond ships and rigs is a much bigger problem: there is no infrastructure or workforce in the Arctic. Marine vessels, airports, road access, municipal support, and all of the conveniences of civilization simply do not yet exist in the frozen north. There are no deepwater ports either, which limits offloading capabilities.

Completely commonplace activities like trenching and laying pipe are a whole different game in ice covered waters. Simply knowing when to expect ice, and how much, is another area that needs improvement.

Evacuation and rescue operations in the Arctic must be self-sufficient, because it's so remote; backline support systems are simply too far away. By the same token, mobilizing fast responses to oil spills requires a local self-sufficiency that currently does not yet exist.

Wildlife protection, cooperation with indigenous tribes, and a "don't spill a drop" ethos mean that oil companies must be extremely careful in the Arctic, and take a holistic view of their activities encompassing the needs of all stockholders in the area, including social needs.

More Than Technical Issues

One such non-technical but crucially important challenge is working successfully with the First Nations (aboriginal tribes) of the Arctic. Many areas under development are the property of Inuit and other natives.

Nick Poushinsky, the Senior Vice President of infrastructure consultancy Stantec (NYSE: STN) explained some of the issues, speaking from his long experience working for the Canadian government in negotiating resource development agreements with aboriginal people. He now works for companies owned by them, which are developing joint venture partnerships with Devon Energy (NYSE: DVN) and ExxonMobil (NYSE: XOM), and working on Beaufort Sea development.

It takes a great deal of effort, he said, to work through issues like royalty regimes, environmental protection, and not interfering with native rights to traditional hunting and fishing. The best time to move ships through the Arctic is in warm, ice-free seasons, which is also when wildlife need to move through it.

Along with environmental concerns and oil spill prevention have come a host of regulatory issues in which conflicts abound; according to Poushinsky, it has "gotten totally out of control." For example, Americans want to protect polar bears, but at $100,000 a head, the Inuit want to hunt them. The US Environmental Protection Agency will not allow testing and research on the water, so those working toward US development of the resources must turn to Norway and other partners for that.

Royal Dutch Shell (ADR: NYSE: RDS.A) and ConocoPhillips are going well outside their domains of expertise, spending $100 million per year on biological and geological research in the Arctic, studying such things as climate change and environmental factors affecting polar bears, seals, walrus, and whales.

Recognizing the importance of their oil and gas resources, aboriginal peoples are starting to feel their oats and demand a piece of the action, exchanging access to their lands for something else. Their aspirations are very high, but they lack the necessary skills and capabilities to participate in building the Arctic infrastructure. At the same time, crews imported from warmer climes often find the conditions unpleasant, and don't come back after their first tours. Manpower and training are desperately needed at the earth's northernmost extremity.

Finally, there are the jurisdictional challenges. Everyone is amused by Russia's planting of a flag at the Arctic, but that was just a publicity stunt. Real oil and gas production can only happen after successful resolution of border disputes. Canada has ongoing border disputes with Denmark, the US and Russia. The US also has its own border conflicts with Russia. Greenland is seeking revenue that will allow it to separate from Denmark, and Iceland is anxious to retain its share of the spoils because one-third of its exports are derived from energy.

The Race Is Afoot

Still, as Mead Treadwell, chair of US Arctic Research Commission noted, if the US does not exercise its visible presence in the Arctic, we cede it. We can't put a ‘keep out" sign on the ocean, she said; it's open to any and all who can get there and develop it.

Nation-states tend to be adversarial in these discussions, Poushinsky observed, taking hardline positions on the issues and refusing to talk to each other. Once the parties sit down and negotiate, results are easier to come by. "We gotta get over this kinda crap," he sighed in a long-suffering tone.

All speakers seemed to agree that a great deal of international cooperation is needed across the board to develop the Arctic. Environmental studies and protection, seismic surveying, spill prevention, protecting the subsistence of indigenous residents, developing drilling and shipping standards, providing infrastructure, and a slew of other crucial areas all transcend borders.

Yet as I said last week, given the pressure of peak oil on supplies, and a global demand for petroleum that has proven to be remarkably resilient in the global recession of the last year, it seems a foregone conclusion that the Arctic's buried hydrocarbons will be developed. It's not a question of if, but when.

And, of course, who will benefit from it.

Until next time,

Chris

Investor's Note: Hopefully by now you've realized just how far we'll need to go to develop our future oil supply. That includes drilling at the ends of the earth, literally. But here's the dirty little secret: Investors don't have to wait until the rigs begin drilling the Arctic seabed. In fact, members of the $20 Trillion Report banked an easy 30% from their first offshore trade in 2009—and that was when oil was struggling to reach $40 a barrel! If you'd like to check out these profits for youself, simply click here.

The Horn River Basin

Let's face it, there hasn't been much pushing natural gas lately.

While oil prices are trying to find support at $70 per barrel, natural gas has stubbornly remained under $4/Mcf. At least, that's been the theme for natural gas in 2009 so far.

The problem stems from the current surplus of natural gas. Also, shale production had a record-setting year in 2008— U.S. onshore production jumped approximately 9%. Things were looking great for natural gas producers, and investors couldn't have been happier. . .

That is, until the economy hit the proverbial fan. The ensuing disaster destroyed demand, and prices deteriorated quickly. Demand has dropped by an estimated three billion cubic feet per day since last October.

When you take into account the production growth from those shale plays, it's no wonder prices plummeted. There was no way to alleviate the glut of natural gas. Companies were forced to scale their drilling efforts back drastically.

As much as I'd like to predict that natural gas will head back over $15/Mcf this summer, I think we can all agree it won't happen. In fact, there will be quite some time before we see that price again.

Several other analysts have preached to their readers about prices dropping below $2/Mcf, but I simply don't believe it.

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And even after watching prices slide more than 75% since last July, I can't think of a better time to get back into natural gas.

For starters, drilling activity has been crushed. In the U.S., there are currently 700 active rigs drilling for natural gas. That's compared to over 1,600 rigs running a year ago. The downturn in drilling will undoubtedly have an effect on production this year.

Once we move into the heating season, we may finally begin to see demand pick up again. Furthermore, any good news for an economic recovery will help push demand higher.

I know what some of my readers are thinking: "What about LNG?"

Many of my veteran readers know that I'm not a huge fan of liquefied natural gas. Even though the U.S. is expected to receive more LNG this summer, I'm still not convinced. According to the EIA, LNG imports in 2009 thus far aren't enough to get excited over.

The reason for my lack of faith in LNG shouldn't come as a surprise. When demand finally begins to pick up again (and it will, dear reader— all it takes is time), those shale plays are going to make a comeback.

One in particular has managed to stay below the radar. . . until now.

The Best-Kept Secret in Natural Gas Discoveries

Ask yourself, "What's the first thing that comes to mind when someone asks me about shale gas?"

I'd bet the answer is one of the prospective shale plays in the U.S., whether it's the Haynesville shale in Shreveport, Louisiana or even the Marcellus shale stretching across several states, including Pennsylvania, New York, Ohio, and West Virginia.

You might even think of the play that started the shale bonanza: the Barnett shale in Texas. Companies were able to extract the natural gas from the Barnett shale as early as 1980. People really started taking notice after advancements were made in fracturing techniques and horizontal drilling.

After the success of shale production in 2008, the cat was out of the bag.

Companies quickly rushed to grab as much land as possible, and the major players established their positions. However, one shale play in British Columbia was lost in the frenzy.

The Horn River Basin Discovery

The Horn River Shale Basin is located in the northeast corner of British Columbia. Don't feel bad if the name doesn't ring a bell. Truthfully, not many people have heard of it. Nevertheless, this shale gas field is being hailed as the largest in Canada.

And much like the U.S. shale plays, the Horn River shale is huge.

There's an estimated 250 trillion cubic feet of natural gas in the formation, and up to 20% of it is considered recoverable. Considering the fact that Canada's natural gas production has been in jeopardy, this can only come as good news to future production.

Since the Horn River Shale Basin is relatively new to the scene, investors have several options open to them.

Investing in the Horn River Discovery

Of course, the usual suspects are present in the Horn River basin. Apache Corp. (NYSE: APA) and EnCana Corp. (NYSE: ECA) each operate on half of their 400,000 acre position. Both have also performed admirably since early March.

However, that's not the only road available for investors.

Last year, I told my readers the Horn River basin wasn't going to be an overnight success. In order to bring this production to market, the Horn River shale will need to develop a better infrastructure.

If you're looking for a strong infrastructure play, take a closer look at Spectra Energy Corp. (NYSE: SE). The company is planning to raise capital expenditures to approximately $1 billion next year.

Like every other energy company, Spectra has had to cut spending this year due to lower natural gas prices. The company has announced it is looking to expand its gathering and processing capacity in the Horn River shale.

Then again, if you're waiting for natural gas prices to reach $15/Mcf before making a move, you've already lost the game.

Until next time,

Keith Kohl

Energy and Capital

Investor's Note: Developing shale plays like the Horn River basin are going to play a strong role in future production. That much has been evident over the last few years as shale production has taken off. And profiting from these new shale basins is nothing new to members of the $20 Trillion Report. Don't wait for energy prices to peak again before you decide to find those profits.

Arctic Oil Reserves

One way to know that the end of the Age of Oil will soon be upon us is the current excitement and chatter about going—literally—to the ends of the earth to find more oil.

The Arctic Circle, which circumscribes about 6% of the earth's total surface, is one of the last regions of any significant size to be explored for oil, and for good reason: It's locked in ice for much of the year, far from support and distribution lines, and is one of the most extreme environments on earth. Whatever oil and gas is extracted from the top cap of our planet will be the most expensive and difficult oil ever produced.

Yet the prospect of new oil production from the Arctic is attracting renewed attention as the world becomes increasingly cognizant of the end of cheap, easy oil, and the security and economic risks associated with the expensive, difficult oil that remains. Exploration opportunities are diminishing every year, as the world continues its 40+-year-long slide down the backside of the exploration bell curve.

With global warming causing the polar ice pack to break up and retreat, it has become possible to sail ships through the Northwest Passage for the first time in recorded human history. (When it was last open is not known, but it could have as recently as the Medieval Warm Period from 1000-1300 AD, when Norse and Icelandic explorers settled Greenland, or distant as the last inter-glacial period, 120,000 years ago.) Thus it now seems at least physically possible to tap the fossil fuel resources of the Arctic.

More specifically, the focus now is upon offshore resources in the Arctic Circle, in continental shelves under less than 500 meters of water. Onshore areas in the region have already been explored, with some 40 billion barrels of oil (BBO), 1136 trillion cubic feet (TCF) of natural gas, and 8 billion barrels of natural gas liquids having been developed, primarily in the West Siberian Basin of Russia and on the North Slope of Alaska. Deepwater basins in the Arctic Circle are considered weak prospects as they lack the appropriate source rock structures.

The important question now is: How much remains to be discovered up there?

In an effort to answer this question, the United States Geological Survey (USGS) in cooperation with an international group of geological experts from Canada, Demark, Greenland, Norway, Russia, and other governmental agencies has just completed an effort to round up the available data on the Arctic region and assess its potential, known as the Circum-Arctic Resource Appraisal (CARA). Their summary report, "Assessment of Undiscovered Oil and Gas in the Arctic," was released last week.

Much of the area is as yet unexplored, so an innovative approach to assessing the area and extrapolating from the limited data available was required. In order to have some way of evaluating the "very sparse geological data" on the area, the evaluators used "analogs" from the real world as comparison samples.

The team divided the area into 69 Assessment Units (AUs) that contained at least 3 km of sedimentary rock, since such source rocks are where the vast majority of oil is found. It limited its assessment to resources thought to contain at least 50 million barrels of oil, or 300 billion cubic feet of gas (50 million barrels of oil equivalent, or MMBOE). According to the report, fields larger than 50 MMBO make up more than 95% of the world's known oil and gas resources by volume, so the limit gives us a good approximation without pretending to more detailed understanding than is warranted by the data. It also considered only conventional oil resources, excluding unconventional resources such as coal bed methane, gas hydrates, oil shales, heavy oil and so on.

Most importantly, it presented its results "without reference to costs of exploration and development."

Maps of the resources reveal their uneven distributions: Sixty percent of the oil is concentrated in just six AUs, predominately in Alaska, and two-thirds of the undiscovered gas is in just four AUs, predominately in Russia.

Figure 1: CARA Assessment of "Mean Estimated Undiscovered Oil" in Arctic Circle
Source: "Assessment of Undiscovered Oil and Gas in the Arctic," Gautier et al., Science, May 2009.

Figure 2: CARA Assessment of "Mean Estimated Undiscovered Gas" in Arctic Circle
Source: "Assessment of Undiscovered Oil and Gas in the Arctic," Gautier et al., Science, May 2009.

A range of probabilistic estimates were developed for the assessment units, which were then aggregated into the summary report. Estimates of undiscovered resources are customarily stated in terms of a range of probabilities. The median, P50 estimates (50% probability) are usually reported in the press, but they're often shown to be optimistic once a given resource is produced.

The USGS report estimates Arctic reserves as follows.

Probability	Oil (BBO - billion barrels)	Gas (TCF - trillion cubic feet)
95%	44	770
50%	83	1547
5%	157	299

Interestingly, an analysis by respected petroleum geologist Jean Laherrère in March 2008 on The Oil Drum estimated that the Arctic would contain 50 billion barrels of oil and 1000 TCF of gas, putting his estimates just above the P95 estimates offered by the USGS. Laherrère is one of the fathers of the modern peak oil study, a man with deep experience in the global oil and gas exploration and production industry, and his estimates are usually quite accurate.

To give a sense of scale to these numbers, world oil consumption is around 30 billion barrels per year, and world gas consumption is about 110 TCF per year. So the Arctic may contain anywhere from a 1-3 year supply of oil and a 7-27 year supply of gas.

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However, these are merely estimates of "original oil and gas in place." Typically, only 25-35% of that amount is economically recoverable using current technology. So the Arctic may in fact have perhaps a 4-month world supply of recoverable oil, and around a 2-year supply of gas.

In reality of course, the resources wouldn't be found or produced all at once, but rather in chunks, over time, and would have far greater implications for the nations that lay claim to it (for example, Greenland) than for the world as a whole. "With respect to oil, there's nothing that we see in the Arctic that suggests this preeminence of oil within and around the Gulf states would be significantly shifted," said geologist Donald Gautier, lead author of the survey.

Given the scarcity of actual drilling data and the reliance on analogs and statistical simulation for this survey, our understanding of the Arctic's hydrocarbon potential will no doubt evolve as fresh prospecting gets under way. In terms of the all-important production rate however, it seems safe to assume that although the Arctic's resources will be most welcome to the nations that possess them, they will amount to little more than a trickle of very expensive hydrocarbons within the context of enormous world demand.

Exploration and development of oil and gas from the Arctic Circle is a foregone conclusion. The world simply needs hydrocarbons too much, and the remaining prospects are few. But to exploit it will require technologies that don't yet exist, enormous amounts of capital, and a high tolerance for risk. In other words, the price of oil will have to be high, and stay high, to make the effort worthwhile.

Next week we'll take a look at some of the companies that are working to explore and develop the Arctic, and the cutting-edge technologies they are developing.

Until next time,

Chris

Investor's Note: While the race for Arctic oil continues, investors need to realize that actual production from this area is years or maybe even decades away. But that doesn't mean you need to wait that long to profit from deepwater drilling. If you're interested in taking some of those offshore profits to the bank, perhaps it's time you joined our success.

Oil Implications for Cleantech Investors

The future price of oil is a vitally important consideration for cleantech and renewable energy investors. When prices are high, it's good for cleantech, and when they're low, it's bad. Yet too few cleantech investors are equipped with the ability to forecast them.

The price of oil is set daily and globally by a complex interaction of many factors, including supply and demand, relative valuations of currency, speculation in oil futures, delayed feedback loops, economic growth rates, money flows of large investors, geological factors, geopolitics, and many more.

Oil shot to $147 in 2008 because of a particular highly leveraged alchemy of those factors, and it fell to the low $40s today as the leverage unwound and global recession took its toll on demand. Such volatility makes for an extremely cloudy investment outlook, particularly when the investment horizon is measured in decades. That volatility is likely to increase in the coming years.

In order for cleantech investors to succeed then, they must have a deep and rigorous understanding of these factors and be able to anticipate oil prices.

Here are a few essential clues to reading the oil markets. (See also my article of last week, "Updated Oil Price Outlook.")

Global Oil Production Has Peaked

The rate of global conventional crude oil production has been stuck at roughly 74 million barrels per day (mbpd) since 2005, despite a tripling of oil prices over that period, ending oil's long history of supply growth. This is predicted by peak oil models, which describe how oil production grows, peaks, and then falls in a rough bell curve shape for any given oil producing region. All increases in "oil" supply since 2005 have come not from regular conventional crude, but from unconventional liquids such as heavy and deepwater oil, oil sands, natural gas liquids, and biofuels, bringing the world supply of "all liquids" to between roughly 84 and 86 mbpd since 2005 (Energy Information Administration, April 2009 International Petroleum Monthly).

Figure 1: World Oil and Gas Production Profiles, 2008 Base Case

Source: Colin Campbell, ASPO Newsletter No. 96, Dec. 2008

A close study of the all liquids peak reveals a bumpy plateau from roughly 2005-2012, after which oil production will go into terminal decline. The absolute peak will likely prove to have been July, 2008.

The International Energy Agency (IEA) projects that under normal circumstances with regular maintenance and investment, simple depletion of mature fields will cut about 5% from the global supply each year, which is far in excess of what new oil projects may hope to offset.

While the world is certainly not "running out of oil," since nearly half of it is yet to produce, the world has definitely run out of cheap and easy oil. From now on the oil we produce will be progressively harder to get, and more expensive. This point has been emphasized in recent years by the CEOs of nearly all major oil companies, as well as the major oil data providers like EIA and IEA.

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Production Cost

The cost of producing oil varies widely between under $20 for old projects in Saudi Arabia, to $100 and up for sources like oil sands and shale. The global average cost of a new barrel of oil production capacity has been estimated at between $60-80.

Figure 2: Oil Production Costs

Source: Cambridge Energy Research Associates

The domestic budgetary needs of producers also play a role, with OPEC producers needing at least $50-60 oil, and Russia needing $70.

Future production costs will be even higher. Credible experts maintain that oil will have to remain above $100/bbl before investors will commit to the expensive and risky marginal projects that will deliver the oil we need over the next several decades.

Figure 3: Oil Production Costs and WTI Price

Source: CIBC World Markets, StrategEcon Jan 23, 2009

Saudi oil minister Ali al-Naimi has warned that the world needs $75 oil to sustain ongoing investment. Current prices "are wreaking havoc on the industry and threatening current and planned investments," he said.

With oil selling for half the new production cost, only older conventional fields are currently profitable. Well-capitalized companies like Chevron and Shell can afford to continue investing with such an uncertain horizon, but marginal producers have been forced to lay down their rigs and cut back on development as credit availability fell along with prices.

Consequently, projected new oil production for 2012 and beyond may not materialize, for a lack of investment now. It typically takes 2-10 years for oil production to commence once a project has broken ground.

Under-investment is precisely what the IEA warned about in its World Energy Outlook 2008, in which they said the world would need to invest over $1 trillion dollars per year for the next 22 years just to maintain current supply levels. Under the current credit crunch and low oil prices, that kind of investment is simply not happening. This is likely to accelerate the global decline rate to 9% and above, according to the IEA.

Oil Is Priced At The Margin Of Supply

A thin, roughly 3% margin in spare production capacity is the prime mover of the oil markets. Supply remained flat while demand grew from 2005 through the first half of 2008, driving spare capacity from over 2 mbpd to less than 1 mbpd, which precipitated a spike in oil prices. When demand fell sharply with the global recession, spare production capacity grew to more than 4 mbpd, and prices overshot well below the production cost.

When the global economy recovers, perhaps in the 2010-2011 time frame, spare production capacity will collapse to a thin margin, and prices will spike again. BP Chief Executive Tony Hayward said in November, "Increased demand will stretch the system to its limits, and this will cause another upward spike in the price."

	2006	2007	2008	2009	2010
World Oil Demand:
OECD	49.6	49.1	47.6	45.4	45.9
-% chg	-0.	-0.9	-3.2	-4.5.	1.0
non-OECD	35.4	36.7	38.0	39.1	40.8
-% chg	3.6	3.5	3.6	2.9	4.3
Total World Demand	85.0	85.9	85.6	84.6	86.7
-% chg	1.2	1.1	-0.1	-1.2	2.5

World Oil Supply	84.5	84.4	85.8	85.5	84.8
-% chg	-0.2	-0.1	1.6	-0.4	-0.8

Excess Supply	-0.5	-1.5	0.2	0.9	-1.9
(+ve)/Demand (-ve)
West Texas Crude, Year-end ($/bbl)	61	96	45	65	100

Table 1: World Oil Supply, Demand and Balance (mbpd)

Source: US Dept of Energy (history), CIBC World Markets (forecast)

Volatility

In the coming decade, we should expect a series of cycles like the one we saw over the last 12 months. As supply remains flat and begins to decline, demand will dictate the price. As global demand increases along with economic recovery, spare production capacity will quickly diminish to almost zero, and prices will spike again, causing demand to crash and prices to fall. As these cycles continue, we may expect volatility to increase.

For cleantech investors, this is both good news and bad news. Poor price visibility will tend to restrict investment capital in the oil patch until such time as the global oil price stabilizes above $70 a barrel. At the same time, the predictability of the renewable energy cost structure will increasingly favor it. For example, investors may come to view a modest 4% return on a third-party solar financing arrangement as a very desirable and stable investment.

For oil investors, current prices are an unquestionable bargain. Oil infrastructure providers and companies with sizable reserves now offer the investment opportunity of a lifetime.

Ultimately, the decline of oil, followed by the peak of natural gas and coal in roughly the 2020 - 2025 time frame, means that renewable energy and energy efficiency technologies probably cannot grow fast enough to fill the gap. Therefore, the growth opportunity for those sectors is essentially unlimited for the foreseeable future.

For detailed data, charts, and analysis on the peaking of fossil fuels and the renewable renaissance, investors may want to explore my exhaustively referenced book, Profit from the Peak (Wiley, 2008). My second book, co-authored with my colleagues Jeff Siegel and Nick Hodge of Green Chip Stocks, is Investing in Renewable Energy (Wiley, 2008) and offers a more detailed focus on renewable energy and cleantech.

Until next time,

Chris

Energy and Capital

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Updated Oil Price Outlook

"Prediction is very difficult, particularly about the future." - Niels Bohr, winner of the 1922 Nobel Prize for his work on the structure of atoms

In my line of work, nothing is so bedeviling as predicting the price of oil and gas.

Accordingly, most analysts who have been at the study for a few years take pains to avoid making price predictions. Good calls are rarely remembered, and bad calls are rarely forgotten. Price targets become fodder for those who lay in wait for a "gotcha" moment that might stain one's credibility.

Those in the oil industry also try to avoid discussing price. When it takes ten years or more and billions of dollars to develop a large deepwater oil project, the volatility of prices that we saw over the last year makes for a very difficult investment planning horizon. Oil companies must therefore take a long view on their commitments, betting that prices will rise over time.

In a blogger conference call last week with Robert Ryan, Chevron's vice president of global exploration, I asked three questions about how oil prices affect their decisions to pursue new deepwater projects. He declined to comment specifically on all three, emphasizing their long-term strategy. I really couldn't blame him for it. (Chevron just began pumping oil on May 5 from its new Tahiti platform in the Gulf of Mexico, which is operating in 4,100 feet of water and lifting oil from 26,700 feet below the seabed, making it the deepest well in the Gulf. The cost of the first phase of the project is $2.7 billion, and the platform is expected to ramp up to a flow rate of approximately 125,000 barrels of crude oil and 70 million cubic feet of natural gas before the end of the year.)

For oil and gas investors, though, there is no skirting the price question. To get an idea of where prices might be going, we must look at the market from several different angles.

Key Factors Affecting Oil Prices

First, consider the fundamentals of supply and demand. On this point, the data is decidedly bearish. In its monthly Oil Market Report issued last Thursday, the International Energy Agency (IEA) revised its world oil demand number downward by 2.56 million barrels per day (mbpd) to 83.2 mbpd, which would make the sharpest annual decline since 1981

At the same time, worldwide inventories are extremely high, with some 150 million barrels of oil and products estimated to be in storage at sea. An historically long and sharp period of contango in the oil futures curve has encouraged speculators to buy oil while prices were low in Q4 2008 and Q1 2009, and store it until prices returned to normal levels. (For more on this subject, see "EIA's Oil Outlook Report.")

But if demand is still falling and supply is still rising, which should bode lower prices, then what shall we make of the fact that oil hit a 6-month high at $60 last week, after falling into the low $30s?

I tend to agree with the IEA that rather than responding to fundamentals like supply and demand, oil has been following the broader market. Oil prices have followed the major indexes very closely since the market crash last October, and have trended up along with the overall market since the March 9 bottom. In other words, oil has been trading on sentiment about recovery, not fundamentals.

However, there is some indication that the oil trade may be getting back to normal in that it is once again trading inversely to the US dollar. The relationship fell apart from roughly October through February as the markets became singularly focused on the financial and credit crisis, but now appears to have returned:

West Texas Intermediate vs. USD. Source: Bloomberg via RBC Capital

For further reading about this important relationship, see "Oil and the U.S. Dollar."

Another signal of returning normality is in the implied volatility of the oil futures curve, which is now within 3% of its 52-week low:

Source: CurvingFutures.com

This suggests two things: One, that the uncertainty about the future price of oil has diminished, and investors are less interested in insurance against sudden price moves; and two, that the market is probably underestimating the likelihood of future price spikes.

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I think we can safely rule out another factor that was very influential on oil prices last year: that of piracy, sabotage and geopolitical posturing by major oil producers. All of that continues to this day—indeed, the MEND militant group in Nigeria struck a new high note of aggression last week, declaring a civil war against government forces and warning foreign oil workers to evacuate from the Delta immediately—but with global spare production capacity now at least 4 mbpd, it really doesn't have the ability to move the market.

A final important consideration is the production cost of oil, on which I have written frequently since last November. (See: "The Truth Behind Low Oil Prices," "The Looming Energy Crisis," "EIA's Oil Outlook Report," "OPEC Defends Oil Prices," "Oil Prices Are Wrong—Very Wrong," and "The Sleeping Threat of Low Oil Prices.") At under $65 a barrel, the marginal production on which we now depend for future supply simply doesn't make economic sense. Oil really needs to be over $100 to ensure supply a decade from now.

This underpinning factor has prompted the Secretary General of the IEA, Nabuo Tanaka, to warn that oil prices could reach as high as $200 a barrel over the next four years when global demand recovers. Still, while this argues strongly for taking long-term positions in oil, it is a fundamental factor, and as such probably bears little on the short-term price outlook.

Whither Oil Prices Now?

At this point, the outlook is substantially murkier. We're almost up to a good price floor to support renewed drilling, but we're not quite there yet, and rig counts continue to fall. Supply and demand data are bearish, but the broader market's continued move upward is bullish.

Investors seeking a safe haven against the renewed specter of inflation in the wake of quantitative easing are beginning to nibble again at the commodity sector, and hedge fund money appears to be coming off the sidelines and establishing positions again, portending another leg up in prices. At the same time, I think the unwinding of the speculative storage play in oil may be in the cards within the next several months. Should long-dated futures begin to fall, or near term prices reach toward $70, it could unleash a flood of selling of all that oil in storage, and crush spot prices.

Given the uncertainty of the price outlook, I think it's prudent for active investors who are sitting on double-digit gains to take some off the table at this point. Investors who followed my thesis and began accumulating oil since November have enjoyed gains of 50-100%, because oil had been so deeply oversold. It took guts to do that while many pundits were calling for $25 a barrel, but from a fundamental perspective, it was really a no-brainer.

I would advise those who missed the move up since March against taking large positions now, favoring instead a strategy of slow accumulation as a hedge against the broader market selloff that I continue to believe is somewhere in the fog ahead. We're not out of the bear market woods yet, and caution remains the watchword. Should the market give up its recent gains and take oil down along with it, there is little in the way of fundamentals (other than production cost) to support prices through the rest of this year.

At the same time, short-term investors should be able to pocket some quick gains in the oil patch as long as the overall market continues to move up. Financials remain the key sector to watch here.

Finally, for long-term investors willing to hold oil for another year or more, I believe the fundamentals support holding onto to those positions and adding to them on the dips. Likewise, investors who took my suggestion to start accumulating positions on natural gas at the beginning of April (see "Natty Dread") had an opportunity to sell it with a 20% gain one week ago, and are now looking at another buying opportunity as it has descended to under $4 per Mcf again.

Until next time,

Chris

P.S.Whether you're investing in the long or short run, the truth is that there are strong gains to be made in the markets. My colleague, Ian Cooper, is putting that fact to the test. Ian recently began his 'Fifty-Trade Gauntlet', proving that smart investors can still make a fortune in today's market climate. And if you haven't had the chance yet, I suggest you take advantage of this opportunity. You can learn more about Ian's "Trading Gauntlet" by clicking here.

P.P.S Thanks to options trader and blogger Steven Place (@stevenplace on Twitter) and Jeffrey McLarty of (@jmclarty) for their contributions to this article.

Venezuela Oil Fields

When in doubt, just take it all.

If someone complains, take it anyway.

At least, that's been Hugo Chavez's mantra towards foreign oil companies. And if you think he's done, guess again. This time, however, the consequences of his sweeping nationalizations could very well be a blessing to your oil investments. (I'll get to that in a minute.)

You see, an interesting question came from one of my readers late last week. Right away, a strange feeling hit me.

The question was, "Where would you rather have your oil investments operating, Nigeria or Venezuela?"

"The answer", I told him, "is neither." That was a no-brainer. Quite frankly, the mere thought of operating in either of those countries is enough to make me cringe.

Naturally, he sent back a quick reply saying he couldn't agree more. He went on to answer the question I was ruminating on for the better part of a day — I knew I'd been asked that question before.

At the end of his message, he mentioned that this wasn't the first time he asked me that. Being an email pack rat (I have an odd habit of never throwing away old emails), I soon found out he was true to his word. It turns out this gentleman sent me the exact same question nearly two years ago. On an interesting side-note, my response back in 2007 was nearly identical.

Some of you might remember the May Day takeover. In May 2007, Chavez seized operations in the Orinoco River Basin oil field from six major companies. The move effectively gave Chavez control over the remaining private oil fields in Venezuela.

At the time, Chavez said the May Day takeover was the "last step" in taking national control over its domestic resources.

I guess he changed his mind.

Chavez Seizes Oil Service Companies

Chavez further tightened his grip on Venezuela's oil industry after wresting control and seizing the assets of oil service contractors. The law was passed on May 7, and assets were stripped the next day. A total of 30 barges, 13 drilling rigs, 399 boats, and 39 terminals belonging to approximately 60 companies were taken.

I'd bet a lot of you saw this coming from a mile away.

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Once crude prices began to tumble from a high of $147 per barrel, PdVSA (Venezuela's state-run oil company) stopped paying oil service companies. By the end of 2008, nearly $14 billion was due. And Venezuelan oil production hasn't been pretty.

Despite the fact that the country claims it produces over three million barrels per day, that amount has fallen to under 2.3 million barrels per day. Also remember we're talking about heavy and very sour oil.

And even though these companies will be compensated for their loss, can we really expect them to get a good deal? On the matter of being adequately paid for their assets, I'd like to note that two major oil companies are still negotiating the proper compensation for the May Day takeover in 2007.

In other words, those companies might as well take what they're given. It's simply not worth their trouble.

And don't think that Chavez is finished.

He's already set his sights on his next target. Chavez was quick to report, "All companies performing gas-injection services for oil wells will be seized formally."

It's futile to think Chavez won't continue to strong-arm the oil industry, especially when an overwhelming amount of his social programs are paid for with oil revenues. Oil accounts for approximately 90% of Venezuela's export revenue.

Chavez's greed, however, doesn't have to be all bad news.

The Reason Chavez Could Make You a Fortune

Okay, so Chavez's latest decision was inevitable, especially once you take into account that these oil service companies weren't even getting paid in the first place.

But if we look at this move in the long term, it's nothing but a win-win situation for us.

Taking complete control over their oil industry is going to put Venezuela in a very tight spot within the next few years. The country is already forced to spend billions of dollars each year just to maintain current production. And like the Canadian oil sands industry, the latest oil price shock is going to take a deep toll on developing those heavy oil assets.

This latest move on Chavez's part certainly won't encourage foreign investments.

Unless some miracle happens, Venezuela's production will continue falling (their production is already at 1997 levels).

Now, take into account the fact that over a million barrels of oil are shipped to the U.S. on a daily basis. According to the EIA, Venezuela is sending us about the same amount as Saudi Arabia (the Saudis edge out Venezuela by a small margin).

With Mexico soon to be out of the oil exporting business and Venezuela struggling to produce the heavy oil in the Orinoco Belt, the U.S. is going to have to find a few million barrels of oil from somewhere new.

Only a fool believes the world's economy will never recover. When it does, whether it's in 2009 or even another two years from now, demand will inevitably pick up. You'll be able to ride Chavez's greed all the way to the bank as more prospective oil regions become more vital to global production.

It's only a matter of time, so why wouldn't you position yourself while you still can?

Until next time,

Keith Kohl

Energy and Capital

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Offshore Oil and Gas Technology

The 2009 Offshore Technology Conference (OTC) in Houston sported the most massive exhibit hall I have ever seen, including huge trucks, enormous steel parts weighing many tons, drilling rigs, giant generators and pumps and other assorted gear that makes offshore drilling possible. This week, I take a look at some of this amazing technology.

Greg Evans, "Offshore Eiffel Tower," Acrylic/Canvas

Reporting from the conference last week, I explained why the oil and gas industry must strive under increasingly challenging conditions to maintain or increase their production rates. The world's largest, cheapest and easiest to produce resources have been exploited, and the best untapped resources that remain are in extreme places like the frozen Arctic, or under a mile of ocean water, or in marginal formations like shale.

The oil and gas industry is constantly in pursuit of new technologies that will allow them to develop these remaining resources, like horizontal drilling and fracturing, advanced seismic modeling, remotely operated devices, and subsea systems.

Nowhere is the technology more advanced than in deepwater drilling and production, with modern hardware incorporating everything from giant versions of low-tech nuts and bolts to the ultimate in high-tech hardware and software.

Modern Marvels

Consider the hardware I saw on our tour of Cameron International Corp (NYSE: CAM), the world's top supplier of subsea components. In search of the elusive "unobtanium," Cameron engineers at the Houston facility perform metallurgical miracles, designing and testing deepwater drilling parts against the most tortuous of conditions—temperatures that fluctuate by 500 degrees, under pressures of up to 30,000 psi (by comparison, your household water supply has about 60 psi)—twisting and bending the steel at up to 5 million foot-pounds of pressure to simulate the real-life conditions of a floating drilling rig, all in an effort to prevent oil spills and blowouts in undersea drilling operations.Everything is double- or quadruple-redundant to guard against dangerous and costly failures.

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Their "blowout preventers," for example, are high-tech marvels, incorporating microprocessors, super high tolerance parts, electric motors, seals and other components in a unit that sits on the seabed under incredible pressure and temperature, waiting to disconnect the wellbore from the production system in seconds without spilling a drop of oil on command from an operator miles away.

Cameron Blow Out Preventer (BOP)

Other Cameron products include "Christmas trees" (stacks of valves and fittings that control the flow of fluids from an oil well and prevent their release into the environment), seals, chokes, compressors, control systems, completion equipment, pipe connections, robotic remotely operated equipment to connect equipment at depths divers can't reach, and subsea systems that can separate salt, water, and gas from oil all on the seabed. Their equipment is routinely deployed today in water depths of over 7,800 feet. Not surprisingly, one of Cameron's top customers is one of our long-term favorites, Transocean LTD (NYSE: RIG) the king of offshore drillers.

I got a glimpse of the software end of advanced drilling technology on a tour of Halliburton's "Real-Time Decision Center and Visualization Center." As a former software engineer and architect, what I saw their systems do took my breath away. Halliburton (NYSE: HAL) engineers and their customers can now plot and steer the path of a drill bit from a half a world away, coordinate petabytes of data from disparate sources in real-time, collaborate with engineers in far-off locations, and examine 3-D models of the rocks they intend to drill. Such technology has enabled Halliburton to drill seven hits out of nine attempts in the most extreme drilling conditions in the world-an impressive success rate.

Other major industrial companies at the conference like industrial giant FMC Corporation (NYSE: FMC) demonstrated the capabilities of their floating production storage and offloading (FPSO) systems, which enable the development of deepwater fields in places like Brazil and the U.S. Gulf of Mexico. These systems can collect the oil from multiple wells on the seabed, connect their output to a central "manifold" system, do the processing to remove the water and gas, pump the oil to the surface, and load it directly onto tankers.

Outlook Solid

With an uncertain outlook on oil and gas for the next few years, one might think that the purveyors of these high-ticket items would be suffering from falling orders, and to be sure they took their hits along with the rest of the equities market through the end of 2008. But all found their bottoms starting in 2009, and have staged an impressive rally in the last two months as they followed the broader market up:

The fact is that deepwater production is now the name of the game in oil and gas. If we want it, we're going to have to go there to get it. Oil producers know this and are still pouring billions into its development annually, in the expectation that over the decades that it will take to develop these fields, their investments will pay off handsomely.

In a technical session at the OTC conference, Baker Hughes Inc. (NYSE: BHI) observed that the drop in oil demand in the last big downturn in 1983 was 24% off the peak, whereas demand has only declined 4% in 2009. "The easy oil has been found," declared BHI CEO Chad Deaton, and when the economy rebounds the supply problem will be more intense than ever. He believes that $100 a barrel pricing is needed to ensure future supply, a point I have emphasized in this column (see "The Sleeping Threat of Low Oil Prices").

Or, as Karen A. Harbert, the Executive Vice President and Managing Director of the Institute for 21st Century Energy (a department within the U.S. Chamber of Commerce) put it, "We're going to be wishing for $4 gas if we don't get our act together."

The oil and gas industry faces numerous challenges in addition to prices that are too low. For one, a lack of qualified personnel plagues the business from end to end. A majority of the personnel are over 50, followed by a 10-year gap before reaching the next tier of 35-40 year olds who could take their places—the result of a sharp decline in petroleum geology students during the 80s and 90s. Technical, regulatory and political challenges, delivery scheduling issues, and cost control are major hurdles for the industry as well.

Taken together, the picture for offshore oil and gas development is clear: demand will remain high, and the prices for oil and gas will have to rise for the industry to meet it.

In future columns, I'll share more insights from the OTC conference, including the technical challenges of drilling in the Arctic, the enormous complexity of developing new oil and gas megaprojects costing billions, and some promising new ideas for storing and delivering energy from far-offshore wind farms.

Until next time,

Chris

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Investing in Oil Stocks

The opportunity is out there for investors, yet people are still too afraid to trade.

At least, that's what I told my readers three months ago. At the time, there was little to get excited about with crude oil, which was barely holding steady over $40 per barrel. Inventory levels were still building. Of course, not much has changed on that front, considering U.S. inventories of crude oil have been rising ever since.

Like many of you, I saw some of my favorite oil and gas stocks trading at near 52-week lows. I knew there were a lot of stocks unfairly beaten down, which opened a huge door for investors.

In response, one reader in particular was thoughtful enough to warn me to be wary of calling for higher energy prices during a down economy. I couldn't help but agree to an extent. There was certainly a chance that oil prices might head lower, especially with all the bad news we were reading at the time. Lower consumption levels, higher inventory, you name it.

Then there was another gentlemen who was bit less tactful, and lambasted me for suggesting oil may be headed higher. Needless to say, his caps lock button may have been stuck as he vented his frustrations. His email left me shaking my head sadly. He simply refused to recognize the opportunity in front of him.

It was a mistake I hope many of you don't make, especially in today's market.

How Far Can Oil Run?

It's interesting to watch oil trade closer to the $60/bbl mark each day. Last Thursday, prices rose as high as $58 per barrel before settling back down below $57 per barrel.

It seems like only a matter of time.

However, I'm curious as to whether your sentiment has changed. Granted, the story hasn't changed much on inventory. Lately, it hasn't been a question of whether our inventory level of crude oil dropped, but rather of how much did it increase. That might change now that we're heading into 2009's summer driving season.

Although OPEC isn't meeting until the end of May, Iran has already come out saying more production cuts are on the way. Personally, I think it feels like the same old song and dance.

Then we have Venezuela. And believe me, Chavez has come out swinging again. A law was recently passed that is letting the state take complete control of anything related to the oil industry.

According to Venezuela's Energy Minister, "Companies that are selected for nationalization will not be able to mount lawsuits in foreign countries, because the measure stipulates that disputes will be resolved exclusively by the courts."

For some reason, I'm not too surprised by the bold move.

So, what can we expect for crude in the long run?

Barring some particularly nasty economic news, I don't believe we'll see oil prices below $50 per barrel. If we do, we'll undoubtedly see OPEC take action. Of course, if things keep going the way they have been, we'll probably see $100/bbl oil much sooner than expected.

But here's the interesting part. . .

It doesn't matter.

Investing in Oil Stocks

Investors don't need triple-digit oil prices. The truth is they've never needed $147/bbl crude in order to see their investments make gains.

Let's take those oil and gas companies I mentioned earlier. At the tail end of 2008, I gave my Energy and Capital readers three stocks that (to me, at least) felt beaten down. They were Marathon Oil (NYSE: MRO), Whiting Petroleum (NYSE: WLL), and EOG Resources (NYSE: EOG). A few weeks later, all three had made admirable gains.

Fast forward to early March when I pointed out all three, despite the short term gains, were trading at 52-week lows. The panic selling was just too much. I'm sure my friend with the broken caps lock button would be singing a different tune if he had looked into those energy stocks.

All three bottomed out on that day. Since then, Marathon Oil has managed to climb 46% higher. EOG has been a little more successful, up 68%. Whiting Petroleum, however, took the cake after jumping 109%.

If those aren't attractive gains, I'm in the wrong business.

Like I said before, it doesn't matter if energy prices don't triple in the near future. The point is that there are plenty of opportunities for us.

There's no question where energy is headed in the future. Granted, it's not as easy as blindly throwing a dart against a wall. And even though things are getting better, we're certainly not out of the dark yet. But like everyone else in today's market, you need to start somewhere.

Until next time,

Keith Kohl

Energy and Capital

P.S. Brian Hicks' most recent Wealth Daily essay shares the easiest way to take advantage of the second wave of the energy boom. You can read all about it right here.

The Eagle Ford Shale Play

If you're still waiting for oil and natural gas prices to reach July 2008 price levels before jumping back into your investing, you may want to rethink your strategy.

I'll confess that oil has garnered most of my attention lately. It was easy to get caught up after watching crude nearly break $54 per barrel this morning. Prices haven't been this high for more than five weeks. It also gives us more confidence that oil will be able to remain over $50 per barrel in the future.

But it's not crude oil that's on my mind.

Natural gas has also been on the rise after falling as low as $3.25 per Mcf last week. Prices are finally beginning to recover, trading over $3.60 per Mcf today. The gain today came after the Commerce Department announced that U.S. construction spending grew for the first time in six months.

Although I do believe we'll eventually return to those July price levels, we still won't see it for a few years.

What's the problem?

For starters, we need to see good news for demand. According to the EIA's latest Short Term Energy Outlook, U.S. natural gas consumption is expected to decline by 1.8% this year, and remain flat throughout 2010. Specifically, demand in the industrial sector has to improve. The EIA is projecting industrial demand to fall by 7.4% in 2009. Natural gas makes up almost one-third of the consumption in that sector.

As a direct result of decreased demand, storage levels have remained well above the 5-year average. The EIA reported a working gas storage level of 1.823 Bcf as of April 24, 2009. That was an 82 Bcf increase over the previous week and approximately 464 Bcf higher than the same period last year.

Another problem in the short term is LNG. The EIA projects imports of LNG will grow to 480 Bcf in 2009, compared to the 353 Bcf imported last year. Many of you know I'm not holding much faith in liquefied natural gas. I believe the only way LNG will play a significant role in U.S. natural gas consumption is if domestic production goes down the drain.

That's simply not going to happen in the long run, and there's a good reason. . .

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The Eagle Ford Shale

I have no doubt you've heard about some of North America's shale plays over the last year. In fact, those shale stories have dominated the natural gas markets in 2008. Whether it was the massive reserve estimate in the Haynesville or in the Marcellus formation that initially caught your eye, those shale plays are the reason I'm staying in natural gas.

Take last year, for example. While production in the Federal waters of the Gulf of Mexico fell sharply (roughly 14.8% in 2008) due to the hurricane season, production in unconventional fields grew nearly 10%. Unlike U.S. oil production, which peaked almost four decades ago, developing some of those shale plays has just begun.

One of the up-and-coming shale plays you're bound to hear more about in the future is the Eagle Ford Shale. Located in south Texas, the Eagle Ford Shale formation is found directly beneath the Austin Chalk Shale at depths between 4,000 and 10,000 feet.

The immediate response I get whenever I bring up a new play is, "It's impossible to make money in energy. . . especially right now."

As many of my readers are aware, that's certainly not the case.

Investing in the Eagle Ford Shale Play

Out of the few companies operating in the Eagle Ford Shale, one worth paying closer attention to is Petrohawk Energy (NYSE: HK).

Here's a look at how this company has been doing lately:

As you can see, shares of Petrohawk have jumped more than 66% since early March.

Although Petrohawk's Haynesville operations are enough to get me interested, today I'll focus on the 160,000 net acres in the Eagle Ford Shale.

During the first quarter, Petrohawk drilled and completed two wells. And based off their results so far, they've suggested the Eagle Ford Shale is one of the highest quality shale reservoirs in the U.S. Furthermore, Petrohawk has managed to reduce drilling and completion costs by approximately 60% since the first well. The company is putting approximately $50 million in capital expenditures into developing the Eagle Ford Shale in 2009.

Until next time,

Keith Kohl

Energy and Capital

P.S. I mentioned earlier how some investors are taking the 'wait and see' approach to the energy markets. The truth, however, is you don't have to wait around for years to turn a profit on these oil and gas stocks. As you saw above, you can easily make solid gains from these prospective shale plays. But don't take my word for it, I suggest you check those plays out for yourself. You can learn more by simply clicking here.

Facts and Myths About Offshore Oil

A new battle is brewing over offshore oil drilling. Nine months ago, President Bush lifted a ban on new oil and gas leases off the nation's coastlines, and the congressional moratorium on offshore leasing expired last September.

Now Obama's Department of Interior officials are considering reopening the Outer Continental Shelf (OCS) to leasing, and once again the oil industry is pitted against environmentalists, as well as California residents who remember the ugly mess that a 200,000 gallon crude spill made of the Santa Barbara coast in 1969 after an offshore rig blowout.

I remember that mess. Some time in the mid-70s, when I was 10 years old or so, my family took a trip to California to visit relatives. After nine long hours in the car from our home in the Arizona desert, I wanted nothing except to frolic on the beach when we finally got there, and I wasn't about to let my uncle talk me out of going there no matter how bad it was.

It was nasty. The beach was covered in globs of black goo—so much of it you couldn't avoid stepping in it—and the whole place reeked. (If you haven't ever smelled crude oil, it's smells like exactly what it is: a combination of asphalt and gasoline and everything in between.) We had our fun on the beach, but when we got home, we had to endure a good scrubbing down with turpentine (or maybe it was gasoline) to get the gunk off of our skin.

So I have sympathy for those who don't want to see that sort of thing happen ever again. I've also been an environmentalist all my life.

On the other hand, I believe our energy predicament is shaping up to be so dire as to render all such ideology moot. Taking a principled stance on environmental grounds may soon seem like a luxury of a far-gone age.

Outer Continental Shelf Potential

Let's take a look at the numbers.

According to the EIA (2007 data rounded to billions), total US proven reserves of conventional oil are about 21 billion barrels, of which 4 billion are proved offshore reserves.

US demand is currently about 6.7 billion barrels per year, so if we relied solely upon our proven reserves and were able to produce it as quickly as we like, we'd only have about a three-year supply. Fortunately, we are able to import more than two-thirds of our oil consumption from elsewhere. Nature limits the rate at which we can pump our domestic oil, a rate which has been in steady decline since US domestic oil production peaked in 1970.

Three years' worth isn't much, so we have turned to the difficult and expensive stuff that remains, some of which isn't even oil: low-grade tar sands from Canada, thin seams of shale in the Midwest, and the OCS.

Energy and Capital readers are no doubt familiar with our articles on tar sands and the shales (Bakken, Barnett, Marcellus, and others), but an update on the OCS is probably in order.

The EIA estimates that "technically recoverable undiscovered" offshore oil in the US is in the range of 59 billion barrels—nearly three times as much as our remaining "proved reserves." Most of it, about 45 billion barrels, is expected to lie in the Gulf of Mexico.

The remaining 31% is what was unavailable under the Congressional moratorium, but according to a testimony before the House last month by acting EIA administrator Dr. Howard Gruenspecht, only about 20% of the total technically recoverable oil in the OCS has been under moratoria.

The United States Geological Survey (USGS) numbers are considerably larger, suggesting that some 85 billion barrels of technically recoverable undiscovered oil may remain offshore. (For the present article, I will avoid delving into the murky details of probabilistic reserve estimates and why they differ from source to source.)

In any case, it's clear that the remaining oil prize in the US is offshore. So why aren't we producing it?

Partisans like Sen. Kay Bailey Hutchison (R-TX) would have us believe that it is simply the politics of overzealous environmentalism, banging the drum loudly for offshore drilling and complaining that 85% of the OCS has been off-limits "leaving some of our greatest energy reserves untapped." Indeed, the "Drill Baby Drill" crowd claims that if only we'd drill the OCS everywhere, we could achieve "energy independence."

But if only 20-31% of the OCS has been off-limits, why hasn't the rest been drilled yet?

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Risky Business

One part of the answer is that there simply isn't any oil in some of those areas. Last July, John Hoffmeister, former CEO and president of Shell Oil's US operations, told CNBC "The industry is pursuing the leases it has, but to be blunt, the prospective nature of many of those leases is very low. And you don't go drill oil where you know it doesn't exist."

The second part of the answer is also simple: poor economics.

Offshore oil is expensive, and deepwater oil—wells drilled in more than 1000 feet of water—is more expensive still. Leasing rates for high specification drillships able to produce oil from deepwater formations have run as high as $600,000 per day, which is why we have liked our deepwater drilling players for a long time now.

Consider the economics of the Mars field as an example. At a water depth of 2,940 feet, it is believed to contain 500 million barrels of oil equivalent. The platform produces some 220,000 barrels per day, at a reported development cost of $100 million. Prior to the development of BPs Thunder Horse platform, it was the most advanced platform in the deepwater Gulf of Mexico, where the best prospects for new US oil production are. The Mars platform was destroyed by Hurricane Katrina, and rebuilt by Shell at a reported cost of $200 million. (By comparison, the Thunder Horse platform produces oil at about the same rate, but has a total cost of around $5 billion.)

Deepwater oil also remains a very risky enterprise, even with modern seismic imaging technology. This week Contango Oil & Gas Co. (AMEX: MCF) reported that it would take a $12.5 million write-off for drilling a dry hole in the Gulf of Mexico. It takes a fluid and committed credit market to sustain that kind of risk, but the world is still in the grips of a credit market freeze.

Morgan Stanley recently reported that enough deepwater projects have been scrapped in the global economic downturn to reduce future crude supplies by as much as 2.4 million barrels per day (mbpd) by 2011, a substantial chunk of anticipated supply. Since August 2008, the company reported that no new lease contracts had been awarded, but 11 orders were canceled and 46 more were delayed.

Perhaps the largest project to be delayed recently is the Manifa project in Saudi Arabia. With a $9 billion price tag and a possible 900,000 barrel per day flow rate, it would be the country's largest offshore oil development, but progress has been delayed by six months, probably to take advantage of lower construction costs.

How Do We Reach Energy Independence?

Finally, we must also address the flow rate of any new domestic oil. True "energy independence" would mean producing 18 to 20 mbpd, not the roughly 5.5 mbpd we are producing today. Could we do that?

Through drilling alone, the answer is "not even close." In total, I estimate that if all limits on drilling were removed, including the OCS and ANWR, we could only increase US oil production by a maximum of 2-3 mbpd. That new production would come online slowly, and the additional flow would be hardly noticeable as it compensated for the loss in conventional oil production due to sheer depletion. If it lowered prices at all, it would be by a few pennies per gallon, at best.

Now I have no doubt that Sen. Hutchison understands this, but within the parameters of politics, she must state her case as strongly as possible and try to overcome the resistance to offshore drilling.

Nor do I have any doubt that the hearts of anti-drilling environmentalists are in the right place. Why continue down the doomed path of oil dependency when renewables appear to be right around the corner? Why would the good people of Florida want to court the disaster of oil spills, or look at oil rigs in the distance of their beautiful beaches?

Both sides of the issue, unfortunately, are wrong-headed, and would lead to poor policy. If the public were successfully convinced that we could drill our way out of our energy dilemma, it would stifle development of a renewable-powered infrastructure that will survive in a future of declining oil. Conversely, large oil spills from offshore drilling are a thing of the past, and if we do not drill our remaining reserves with all possible haste we will undoubtedly find ourselves without sufficient oil at an acceptable price within just a few years.

The IEA's warning in February should remain foremost in our minds: If oil demand recovers in 2010, global spare capacity would fall to zero by 2013. And as the world's largest nation dependent on imported oil, we could be in for a very difficult time. The last thing we should do is pull the plug on the majority of our energy supply, which is oil, before we have new forms of energy to replace it. To do so would have terrible consequences on the economy, and hamstring our capability to continue evolving to a new energy regime.

Our only real path to energy independence is to pursue all options, within acceptable emissions limits, and gradually phase out fossil fuels as we ramp up renewables and the electric infrastructure to support them. But while renewables remain less than two percent of our energy mix, we should be careful not to expect too much of them. We will need oil and natural gas for decades to come, and in time we will need to develop our offshore resources or face the prospect of shortages.

Until next time,

Chris

Energy and Capital

Editor's Note: Next week, I will be attending the 2009 Offshore Technology Conference in Houston, by invitation and sponsorship of the American Petroleum Institute. Check in then for my impressions on the cutting edge of offshore drilling technology, and the industry's next great challenges, like drilling the deepwater of Mexico and the Arctic.

Developing the Tupi Oil Field

Judging from the amount of responses I read last week, it's fair to say my readers can be very opinionated.

As you remember, the federal court of appeals yanked the DOI's five-year oil and natural gas leasing plan right from underneath its feet. And truth be told, the last time I saw that kind of animosity was when I sat next next to a group of Yankee fans at Fenway Park.

But just two days after the replies came flooding in, I came across another news release. Right on the heels of the court decision, Florida lawmakers gave the green light to lift the state's ban on drilling off their coast. Furthermore, the house gave the governor and his cabinet power to approve drilling proposals between 3 and 10 miles offshore.

The sudden interest in developing Florida's offshore oil and gas comes with the hope of millions in revenue for the state budget. Naturally, the bill is being lobbied and funded by an unidentified group.

I'm curious as to how many of you are supporting this kind of move. The image of oil platforms dotting the horizon comes to mind. You can leave your thoughts by clicking on the comments section below. Although I never want my readers to pull any punches, just try to keep the commentary publishable (also make sure your caps lock button isn't stuck).

Oil Afloat at $50

If you've been following oil prices closely today, you've probably noticed the $50/bbl mark has been teasing us all morning. After dropping as low as $48.01 per barrel during trading earlier, prices finally found their footing.

According to the media, the latest swine-flu outbreak is the reason for falling crude prices. Their train of thought is that the swine-flu is causing a panic and limiting air travel, thus curbing jet fuel demand and the world economy.

One gentleman in particular told me this single event will flush oil prices back down into the $30 price range.

Personally, I'm not buying it.

For starters, crude oil has nearly erased the losses from this morning's trading. The next test is whether prices can break $60 per barrel this time around. Over the last three weeks, oil bounced as high as $56.10 per barrel.

So if it's not the pig-flu frenzy in the media, what's keeping crude down?

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Let's take a look at U.S. demand. After all, we are the undisputed leader in global oil consumption. And for the last seven consecutive weeks, the EIA has reported a build in inventory levels. Last week, U.S. crude oil stocks reached 370.6 million barrels. That comes out to an increase of 3.9 million barrels over the prior week. Furthermore, that's 54.5 million barrels higher than a year ago.

Needless to say, we're well above the five-year average. In fact, the last time our crude inventory was this high was on September 14, 1990 — nineteen years ago.

Meanwhile, OPEC has been unusually quiet lately. Members insist that $70 per barrel is where they'd like to see prices, but $50 per barrel is "reasonable." Does anyone else recognize this oil dance from before? When oil was at $35 per barrel, OPEC felt $50 was the correct price. I have a feeling that if oil prices were $70 a barrel right now, they would be pushing for $90 per barrel.

Remember, OPEC still hasn't reached the production cuts announced in 2008. And depending on whom you talk to, OPEC members have cut between 80-90% of the proposed cuts so far.

But not all the news I come across is bad. . .

Brazil's Tupi Success

The Tupi offshore field isn't new to us. I'm certain you've heard about this huge offshore discovery at least once over the last year. In fact, it's one of few areas with a bright production outlook. The field is expected to start pumping oil this Friday.

It's also opening up a door for investors.

Before I go any further, I think it's imperative you don't get roped-in from the wild numbers. I've seen some ridiculous production numbers associated with the Tupi field. The one that comes to mind immediately was in an email boasting that the Tupi field will satisfy the entire U.S. demand for the next decade.

First of all, I think my readers are intelligent enough to know the Tupi field won't be producing upwards of 20 million barrels per day this year. Or ever, for that matter. It simply won't happen.

However, we can expect some big action in Brazil. Last week, Petrobras announced the company will be looking for approximately 240 offshore vessels to help develop their offshore resources. We're talking about everything: drill ships, supply ships, storage vessels, etc.

Increasing their oil production will come at a cost. In this case, Petrobras is investing nearly $200 billion with the target of increasing production by 700,000 barrels per day over the next four years.

Since contracts could begin as early as May, there's still a chance for investors to get a piece of the action. Petrobras expects to almost double their number of offshore rigs in the next two years. Next week, I'll tell you which one of those offshore drillers I'm picking up before those contracts come out.

Until next time,

Keith Kohl

Energy and Capital

Offshore Oil Drilling

There's one thing that gives me pause on my way to work. . .

Sitting across the street is a building that has captured my attention each and every morning for the last three years. And no matter what kind of hurry I'm in, I absolutely have to take a moment to stop and admire it.

Built back in the 1940s, it's a landmark for anyone in the area. You can instantly tell it was made with care. From a distance it looks like a massive castle, turrets and all.

But as you get closer, you can see how well every nook and cranny was delicately carved out with purpose. The detail is simply amazing. And although I find some new aspect to admire whenever I walk by, I've never had the opportunity to go inside it. . . until today.

I found myself in a similar situation when I stopped to look at it early this morning. The dark clouds weren't enough of a warning, and a torrential downpour came down in a heartbeat. I quickly took refuge from the rain at the entrance and came face-to-face with the building's doorman.

Not wanting to waste an opportunity to ask, finally, whether the interior was just as stunning, I struck up a conversation with him.

Looking back, I wish I hadn't asked.

According to him, the building has deteriorated quite a bit. The plumbing was a disaster, and there was always something wrong with the pipes. For him, it felt like the walls were crumbling. During the last few years, the price to repair everything has been extremely costly.

No matter what they replace, something else falls apart.

I think some of you will be able to see a striking similarity my building has with our oil industry. . .

It's not just the oil fields that are aging; let's not discount the growing number of rigs and miles of pipelines that need to be maintained. Of course, the fact that oil prices have drastically fallen over the last 10 months doesn't give me much comfort that those expensive ventures can even be afforded.

The times, dear reader, they are a-changing.

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Ten Billion Barrels Busted

When the IEA released their 2008 energy report, there were some disturbing facts that came out. One problem, specifically, is how vital a handful of fields are to our global production.

Over a quarter of the world's oil production came from just 20 giant oilfields. Don't forget that most of these fields are more than 50 years old and in decline. Overall, a little more than one hundred fields make up half of the world's total production (the remaining production is made up of approximately 70,000 oilfields).

As production at those super giant fields wanes, we're going to have to rely more on smaller fields to make up the difference. One would conclude that it's important to continue developing new areas for exploration.

Apparently that's not the case.

Last week, a federal court of appeals tossed out the Department of the Interior's 2007-2012 five-year oil and natural gas leasing plan, citing concern for the environmental impact.

My longtime readers might remember when I talked about the Department of Interior's lease plan back in 2007. As I recall, they expected their plan to generate $170 billion dollars from developing oil targets off the coasts of Alaska and the Gulf of Mexico.

Well, so much for that plan.

As you probably expected, the decision is being both hailed and condemned.

So let me ask you, "Do you think the move was justified?" Please feel free to let us know how you feel about the situation by leaving a comment below. I don't expect my readers to pull any punches on the court's decision.

The Future of Offshore Drilling

What this does mean, however, is that preventing development in these offshore waters will have a detrimental affect on our future production.

Although the effect on longterm prices is still to be determined, I wouldn't expect it to sway current oil prices. Actual production from these lease areas wouldn't have been pumped for several years.

There's another reason I'm not too worried. As I just mentioned, offshore production is playing an increasingly important part in global production. While the giant onshore fields age and decline, we're going to have to drill further and deeper than ever before—simply to make up lost production.

Like the rest of the oil industry, lower oil prices have had an effect on the offshore drillers. They certainly weren't spared the volatility. At the height of $147/bbl oil, day-rates for new contracts could reach up to half a million dollars. We can also add fewer available contracts on top of the declining day-rates.

Here's the thing. . .

Even with the court's decision to put the kibosh on the DOI's offshore lease plan, I'm still banking on the offshore drillers to pull through, especially over the next few years.

I'm not suggesting you blindly throw your hard earned money at any company, praying you hit the big one. I could just as easily torch my cash. As I've said to my readers before, hopes and dreams don't pay the bills.

Instead, I would focus my attention on which of those offshore companies have a strong fleet under contract. How much of their drilling fleet is sitting idle? Which ones have a backlog of work?

Don't think for a second that there's no money to be made in today's markets. For example, I know that most of my readers recently banked a solid 30% gain from just one of these beaten down offshore drillers.

More importantly, however, is that they're a few days away from making another move. It's not fair to my newer readers if I didn't offer you the same chance. Maybe it's time you joined their success.

Until next time,

Keith Kohl

Energy and Capital

Green River Oil Shale

It's easy to get lost in the numbers.

At least, that's what appeared to have happened to several of my readers lately. In fact, the moment they mentioned the Green River oil shales, I knew exactly what distracted them. . .

Although it's been quite some time since I last talked about the Colorado and Utah oil shale, my feelings certainly haven't changed for the better. In fact, it's even worse. And to be honest, the thought of my readers dumping their hard earned money into the area makes me cringe.

You see, I had received the exact same email that was sent to them.

I can only hope that most of you saw waving red flags after reading the first sentence. The opening line announced that this oil deposit would get rid of our dependence on foreign oil. Not lower them, mind you, but rather completely eliminate. That means we'd have to more than double our current production levels. That seems rather unlikely considering U.S. production has been on a downhill slide for the last thirty years.

I knew what was coming before I even read it. The email went on to tout that the trillions of barrels of oil shale underneath Utah and Colorado is our salvation.

I beg to differ.

The Green River Oil Shales

For my newer readers that have never heard of this oil shale deposit, hopefully I can shed some light on the subject. There are actually a few misconceptions about the Utah and Colorado oil shales.

To begin with, they aren't exactly oil shales at all. Rather, they are finely grained sedimentary rock that contain a fair amount of kerogen. As you may know (especially if you received the same email), the largest deposit can be found in the Green River formation, which stretches across three basins in Utah, Colorado and Wyoming.

Companies have tried to develop this resource time and again. Techniques have ranged from surface mining the the rock and then heating the rock in a process called retorting. Basically, the mined shale is broken up in smaller pieces in order to extract the kerogen, which then has to be upgraded.

The process simply requires too much time, money and water. That's also not to mention it doesn't contain as much energy that crude oil offers.

Other projects have tried (and failed) at using in-situ methods. Those of you well versed in the extraction Canadian oil sands will know that this involves heating up the oil shale in ground, then pumping it out using conventional means.

Shell's process, for example, involved drilling holes in a close proximity and heating up the rock. Meanwhile, another set of holes are drilled around the perimeter of the heating section and used to create an ice wall in order to trap the liquid. A final set of wells are then drilled to pump out the oil.

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Caught up in the Numbers

The Green River oil shales started to get more attention as the price of oil jumped over the last few years. It's understandable for the U.S. government to get excited at the possibility of developing the deposit.

After all, we're importing more and more as our domestic production continues to fall. 70% of the oil shale deposit is federally owned, can you really blame them for trying?

Like I mentioned earlier, it's easy to get lost in the numbers. In this case, it's up to nearly three trillion barrels. If we look at some of the lower estimates, there's still supposedly 800 billion barrels of oil that can be recovered.

Of course, many people are quick to make assumptions. As one gentlemen put it, "That's enough oil to last us for hundreds of years."

Sadly, that's not exactly how it works.

I don't think anyone is fooling themselves into thinking we'll be producing enough oil every day to meet demand. He made the mistake of assuming we'll be able to produce anything worthwhile in the first place.

Remember, the total amount of oil produced to date is still only a few thousand barrels.

The idea that we'll be producing 5 million barrels per day in the foreseeable future is laughable. Personally, I put more faith into the development of renewables, especially when we're talking about such a long time frame.

I'm not holding my breath waiting for this to be developed. The development alone is too costly—and that's how I felt when oil was over $100 per barrel!

Perhaps the Green River deposit is just a case of too little, too late. But worse still, however, is the thought of sinking my money into this investment.

Besides, there are much better options right now for investors than waiting 40 years for these oil shales. . .

Until next time,

Keith Kohl

Energy and Capital

P.S. When I said that investors have better places to invest their hard earned money, I meant it. In fact, the Pure Energy Trader has been making double-digit gains, even with this financial turmoil plaguing the oil markets. Members recently locked in a 65% gain in just four weeks! Perhaps it's time you joined them. You can learn more about the Pure Energy Trader by clicking here.

Drilling the Williston Oil Basin

It was late afternoon when my beaten-down Chevy crossed the Canadian border at Portal, North Dakota. I had just come off the tail end of a nine-hour driving shift when my cohort took the wheel. Only a few minutes passed before I drifted off to sleep.

And I have regretted it ever since.

If we were cruising through southern Saskatchewan today, our arrival in Fort McMurray would have been delayed by several weeks, at the very least. At the time, however, we put thirty straight hours and more than 1700 miles of road behind us. Our eyes were fixed on the Alberta oil sands.

By the time I awoke, we were well past Saskatoon.

Fortunately, the way back proved better. It was stunning to watch the rigs that dotted the Saskatchewan landscape.

Last week, I mentioned there was another way to play the Bakken. Many of you already knew where I was headed. That's why I was pretty surprised when several readers wrote-in, asking questions about the 'other side of the Bakken'. They were still in the dark when I mentioned that the formation stretched into Saskatchewan.

Well, it's only fair we open that door for them, right?

The Other Side of the Bakken

Although we've been talking about the potential of the Bakken oil formation for a while now at Energy and Capital, I'd wager most of you started focusing your attention on the area when the USGS reported last year that the Bakken held up to 4.3 billion barrels of recoverable oil.

That was a significant increase over 151 million barrels in 1995.

At the time, oil prices were well under their record highs, and companies were scrambling to grab land. And although the Bakken was good news for U.S. domestic production (which peaked three decades ago, as you know), it wasn't the only option open to investors.

Approximately one-quarter of the Bakken formation is in southern Saskatchewan and holds up to 1.3 billion barrels. I know it's easy to get lost in the huge numbers. Sure, it would be great if Bakken production reached 20 million barrels per day, but that simply won't happen. If Saudi Arabia, OPEC's leading producer, were pumping as much as it could, it would barely be over half that amount.

Throughout this economic downturn, Canada has remained our largest source of oil. While the Saudis shipped us a little over one million barrels every day in January, Canada sent over 2.5 million bbls/day.

Think about that for a moment.

If you remember from last week, we're going to be forced to make up the oil lost from Mexican imports over the next several years.

Can you tell me the last time you heard about public outrage from Canadian oil? Now compare that to how many times you've read about ending our addiction to Middle Eastern oil.

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Drilling the Canadian Bakken

It's no surprise that drilling in the U.S. has taken a hit. And although last week's U.S. rotary rig count was up by a whopping 4 rigs, that's 43% lower than a year ago. Furthermore, you also need to remember that only 224 of those rigs (approximately 21%) are drilling for oil. The rest are going after natural gas.

Rig counts are understandably lower. After all, oil prices aren't exactly in triple digits nowadays.

Drilling activity in Saskatchewan, however, is a bit more optimistic. Saskatchewan is only expecting a 25% drop in the number of wells drilled in 2009.

If oil prices can remain above $50 per barrel, I think we're going to see even better results in Saskatchewan's side of the Bakken. The reason is simple enough, many of the producers see $50 per barrel as economical for their Bakken wells.

The Canadian Bakken Vs. the Alberta Oil Sands

This is how one of my readers phrased a recent comment sent to me:

"When it comes down to it, I can't help but lean toward Saskatchewan. Until oil prices push higher (past $80 per barrel in some cases), the oil sands are going to keep getting hit hard."

But don't think Alberta won't pull through this. If the oil sands producers can survive oil prices under $20 per barrel, they will certainly weather this storm. You see, only 20% of the bitumen in Alberta can be mined at the surface. That's means a large amount of the oils sands production will involve in-situ recovery techniques, which can get expensive for producers.

Investing in the Canadian Bakken

There's no doubt about the growing importance the Bakken will have in future North American production. In fact, it's one of the areas where production will actually increase. This includes both the U.S. and Canadian side.

There are several ways for investors to take advantage of the Bakken. If the latest buyout of Reece Energy taught us anything, it's that many of the smaller players could get swallowed up in a heartbeat. In order to keep production numbers up, those trusts are always looking for ways to keep their attractive distributions steady. Ignoring some of the quality Canadian energy trusts would be a mistake.

Even if the Canadian trusts give you pause, there are still a number of smaller producers with strong production rates and the land to back it up.

Until next time,

Keith Kohl

Energy and Capital

P.S. It's not easy to find the right plays during this recession. I know that many of those Bakken plays have already started coming back, especially now that oil prices are trading steady. In fact, one of those plays has already jumped 30% in the last three weeks alone! If you're interested in playing both the U.S. and Saskatchewan side of the Bakken, I would suggest checking out the $20 Trillion Report.

How To Invest in Natural Gas

As oil prices descended into the $50s, then the $40s in December, I knew that they had overshot any sort of sustainable level. Careful research showed me that oil needed to average at least $65 a barrel to sustain current supply levels, and needed to be closer to $100 to ensure production capacity five years or more into the future.

The price of oil had simply rendered too much production uneconomical, guaranteeing that supply would be quickly constrained when demand picked up again. When that happened, I anticipated that prices would once again spike. I believed that the steep contango of the oil futures curve, pricing oil for delivery in future months at a high premium over the near term, was confirmation that prices would soon begin to move up again.

I suggested that investors should begin to slowly accumulate long positions in oil up through early March (see "The Sleeping Threat of Low Oil Prices"). Those who did were lucky enough to even pick some up in the $30s in February.

My patience was rewarded as prices rebounded to around $55 by the end of the month. That was probably too much, too fast, so it was no surprise to me to see it pull back to the $50 range this week. Again, I view this as a golden opportunity to add a little more to my positions.

The Gas Air Pocket Sets Up

Now I am seeing the same pattern in natural gas (or as traders sometimes call it, "natty"), only the danger of constrained supply is possibly even greater, since about 84% of US natural gas consumed is produced domestically and there is very little storage throughout the system.

Gas prices have plunged 72% from their record of over $13 per Mcf¹ to $3.75 on Monday, taking it all the way back to 2002 pricing. (The spot price for natural gas has only fallen below $4 once since 2002, in September 2006.)

Figure 1 NYMEX Henry Hub prices, 2-year chart

Source: Trading Charts

As with oil, the collapse in prices has forced many drillers, especially marginal producers, to lay down their rigs. According to data from Baker Hughes, natural gas exploration rigs in the United States have fallen steadily from a record 1,606 in September to 884 as of March 13, a more than 45% decline in active rigs.

Theresa Gusman, head of equity research for Deutsche Bank AG's (DB) DB Advisors unit, has estimated that spending on U.S. exploration and production will drop 40% to $22.5 billion this year.

According to a Bloomberg report, the sharp cutback in drilling could produce as much as a 5% loss in gas production in the fourth quarter of this year, even more than the decline projected by the Department of Energy.

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Costs Are Key

Beyond the general decline in drilling, there is another factor that augurs higher prices. Nearly all of the increase in domestic natural gas production we have enjoyed for the last several years has come from the unconventional shale plays we have frequently discussed in these pages, like the Barnett, Haynesville, and Marcellus formations.

Unfortunately, unconventional shale gas is more expensive to produce than conventional gas, and only a small fraction of the potential makes economic sense when gas is selling for $3.75 per Mcf. According to global energy advisory firm Tristone Capital Inc., the average cost of production in the top nine North American shale plays is around $4.50 per Mcf.

Yet there are some producers who can still make a profit at these levels. For example, Atlas Energy reports its drilling costs in the Marcellus Shale—the most profitable of the shale plays, in New York and Pennsylvania—as running $1.49 per Mcf, so drilling continues there, albeit at a slower pace. The Haynesville formation is still profitable as well, but drilling in the Barnett and Fayetteville formations has all but stopped, as the cost of production there is too high. Barnett producers claim they need gas back in the $6-8 range before they'll resume drilling.

This chart of the production cost for major US natural gas producers tells the story plainly:

Figure 2 Natural gas production costs of major US producers

Chart by Chris Nelder. Sum of lifting cost and finding and development data from Southwestern Energy Company SEC Filing, attributed to John S. Herold database, "All data as of December 31, 2005, 2006 and 2007." "Drillbit F&D Cost per Mcfe defined as three-year sum of total costs incurred less the three-year sum of proved acquisitions cost divided by the three-year sum of reserve additions from extensions and discoveries."

At under $4 per Mcf, only about half the producers can break even, let alone show a decent profit.

As the chart shows, Chesapeake Energy Corp., the largest independent natural gas producer in the nation, is suffering for the higher cost of its production. The company has slashed its conventional drilling by 75% over the last six months, and expects to increase its cuts to 85% in the next 60 days. Speaking at an energy conference last week, CEO Aubrey McClendon said, "You simply cannot make money in a sub-$7-and-$8 environment."

Presumably by "you" he doesn't mean ultra-low cost Ultra Petroleum Corp. (NYSE: UPL), or Southwestern (NYSE: SWN), which remains one of my personal favorites as a "pure play" on gas.

In sum, what we're seeing is the destruction of the marginal supply that gave us this surplus. We're cutting back to the bone, and the longer it takes for prices to rise again, the less slack there will be, and the sharper the curve of the price spike. Like oil, we're setting up an air pocket in the fuel line, which we'll hit the minute we step on the gas.

Larry Nichols, chief executive officer of natural gas producer Devon Energy Corp. (NYSE: DVN), also sees the air pocket forming. "When the recession ends and the economy starts booming, we're going to have less natural gas than we do today and prices are going to spike back up," he said two weeks ago. "The drop in supply will be so steep, it could easily catch up to where demand has dropped to before the recession ends."

Supply Nearly Back in Balance

The obvious questions now are: Why is the price of gas so low, and when will it pick up again?

Gas prices are dragging the bottom in part due to an abnormally warm winter in the Northeast, but mostly due to the recession.

Gas consumption in the US is split roughly in thirds between commercial and residential demand (which is fairly constant), electricity demand (which grows at about 5% each year) and industrial demand. It's the latter category which has dropped off sharply in the economic downturn, and which has been most responsible for gas demand destruction. According to the Department of Energy, industrial demand declined 5 percent in the fourth quarter of 2008 from a year earlier, or about 1 Bcf/d (billion cubic feet per day).

As one may expect, this has produced a temporary glut in supply. But if you look at the historical chart of the relationship between gas supply and price, you see that inventory levels generally presage price moves. At this point, we're heading into a slight deficit, and if it continues down under the combined pressure of reduced drilling and increasing demand, we should see the next spike in gas prices.

Figure 3 Natural gas prices and storage deviation from 5 yr norms

Source: Guiness Atkinson Energy Brief March 2009, citing Bloomberg, EIA (March 2009)

US gas consumption varies greatly from month to month, with peaks during winter heating and summer air conditioning months, and valleys around the equinox months. In 2008 it ranged from 50 Bcf/d to over 80 Bcf/d, and averaged about 64 Bcf/d over the year (EIA).

The current oversupply is estimated at about 4 Bcf/d, and will probably fall to 1 Bcf/d by the end of the year as a result of laying down drilling rigs². Remember, 1 Bcf/d is equal to the recession-induced loss in industrial demand, or about 1.6% of average demand.

When industrial demand returns, our marginal supply capacity will disappear, and we'll be back in the danger zone for price spikes and possible shortages. . . potentially by the end of this year!

Prices Rising by End of 2009

Chesapeake anticipates the same turning point, issuing a statement on March 2 saying, "U.S. natural gas production will begin to dramatically decline before the end of 2009 and consequently natural gas markets will regain better supply/demand balance by the end of 2009, if not sooner."

Like oil, the futures curve for natural gas is in a steep contango, suggesting that the market thinks gas is going higher too:

Figure 4 NYMEX Henry Hub futures, 2009-2018

Another factor in favor of higher prices is that on a Btu basis—the actual energy contained in the fuel—natural gas is selling for less than half the price of oil, a very rare disparity. In normal times, the potential for fuel switching ensures that the two trade in a fairly equivalent way, but the last year has been anything but normal times. It's a safe bet that in time, that equivalence will be restored, with the floor probably set by oil.

Another often overlooked, yet potentially important factor for natural gas demand is that the ongoing cleantech revolution could cause us to switch loads from fossil fuels to electric power, particularly in transportation, faster than we build renewable energy capacity to power them. That additional demand will fall on natural gas before it falls on coal. This may seem an outlier price factor now, but it could be a potent one in a few years' time.

When prices do make their next run, they'll probably stay high, as renewed drilling lags the price by six months to a year. Again, gas is mostly a domestic market; imports are limited in size and LNG growth is very slow. You can't just order up tankers of imported natural gas like you can with oil.

A Golden Window of Opportunity

The time it takes to raise capital for new drilling, deploy rigs, and start producing again after gas prices rise is a golden window of opportunity for investors. As long as marginal capacity remains in a razor-thin range, prices will stay high and low-cost producers will be rolling in profits again.

While it's impossible to say when the US economy will recover and bring natural gas prices back into sustainable territory, I am confident that for those with at least a one-year investing horizon, there is no better time than now to begin accumulating those positions.

A stake in one of the low-cost producers shown in Figure 2 would be a fine way to play it, but for now I like getting natural gas exposure not through the producers, whose hedging strategies and rising and falling rig counts will cause their stock prices to moderate and lag significantly behind the price of gas, but by buying into the United States Natural Gas Fund (NYSE: UNG). It invests directly in the near-month futures contracts, so it will respond to rising gas prices fairly quickly.

I realize this is a contrary call. Most pundits, including Cramer two days ago, see little to be excited about in natural gas and expect further selling. The aforementioned analyst at Tristone is actually worried about gas falling to zero, as it did briefly in 2002.

They may be right about further declines over the next few months, but a few analysts like me are expecting gas in the $7-8 range by 2010. With a potential upside of more than 300% within the next two years, I see no excuse for not beginning to accumulate positions now into the cleanest fossil fuel around. I was right about crude four months ago, and I think I'll be proved right about gas a few months from now.

Until next time,

Chris

Energy and Capital

P.S. The price collapse of natural gas may be devastating to some producers, but a few, particularly those operating in Canada and the lower-cost US shales, are veritable gold mines with fat reserves and profitability even at today's low prices. To discover more about them, check out the Pure Energy Trader

1 Units in natural gas vary and can be confusing. For this article I used the more-or-less standard notations Mcf for thousand cubic feet, MMcf for million cubic feet and Bcf for billion cubic feet. (MM represents "thousand thousand"...hey don't blame me, I didn't come up with it). 1 Mcf is roughly equal to 1,000 MMBtu. Gas is often priced in MMBtu, or millions of Btus.

2 Credit to a study by Jon Friese on The Oil Drum, "Natural Gas Supply and Demand Balance," for his excellent analysis.

Drilling the Williston Basin

Don't take your eyes off of OPEC for a second. . .

At least, this was the advice offered to me when oil prices started declining late last week.

Usually, I tend to agree with this sentiment. Certainly OPEC's ability to take oil off the market shouldn't be overlooked. After all, its members are still lowering output by 4.2 million bbls/day, based on two cuts during the latter half of 2008.

This time, however, I'm not too inclined to focus all of my attention on the OPEC. Yes, they do have another opportunity to cut production further when the organization meets on May 28. But the story of oil's recent decline is more likely due to the latest strength of the dollar.

Add to that another weekly build in U.S. crude oil stocks and more bad news for the global economy, and lower oil prices will inevitably fall. If you recall, on Wednesday, the EIA reported a build of 3.3 million barrels to inventory levels. That means levels are 44.8 million barrels higher compared to a year ago.

Sure, it's easy to get nervous when oil loses its rally. Last week, prices were pushed over $54 per barrel. However, oil prices falling as low as $48.11 per barrel today shouldn't cause us to lose sight of what's ahead.

But before I go any further, I think it's important to go over some of the reasons why we might be in trouble.

The Backside of Peak Oil

Late last week, several readers had me worried.

They've unfortunately lost perspective on the future of U.S. oil production. The fact is U.S. oil production peaked more than 39 years ago in 1970.

I'm not just talking about a slight decline.

However, I feel its important for you to see this for yourself. Based on the statistics from the Energy Information Administration, the U.S. pumped out more than 9.6 million barrels of oil per day in 1970. In 2007, production barely averaged over 5 million barrels a day. As you can see, we briefly managed to keep production at a plateau before falling down the backside of the peak.

And if you really want to crunch the numbers, the news is even more grim. In 2008, our production averaged 4.95 million barrels per day. We haven't seen a yearly production average under 5 million barrels since 1946.

Now let's take into account oil's price run to $147 per barrel over the last decade. Even despite all the increased drilling and investments made due to inflated prices, we still failed to increase production.

Take a moment to think about that.

I think we're beyond wishing production would recover. With the loss of investments and decrease in drilling due to low crude prices, how can you not see the storm that's brewing?

The problem is things aren't looking better for anyone else.

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Putting it All Together

Over the last several weeks, there have been several reasons why we should be concerned with our future oil imports. I wish I could sit here and say everything is going to be okay.

And although many of you have shared those same worries, that's not enough. In fact, I think it's just as worrisome that too many people (some of whom are investors) simply don't get it.

Within the next five years, more people will be waking up to the reality of peak oil if they haven't already.

Considering U.S. crude production's spiraling down the drain, the question is how our other sources of oil are faring these days. You've probably noticed many of those import problems on the pages of Energy and Capital recently.

Things aren't so rosy when you look at our top sources for oil:

Canada: As our largest source for oil, Canada was hit hard when oil prices tumbled more than 70% from $147 per barrel. More and more projects are delayed as low prices continue.
Saudi Arabia: Despite their super-giant oil field, Ghawar, being in decline, the undisputed king of OPEC is one of the few members content with oil at $50 per barrel.
Mexico: The loss of the Cantarell field will have serious repercussions for our third-largest source of oil. And as my colleague Chris Nelder pointed out a few weeks ago, Mexico's troubles are our troubles, I couldn't agree more.

Although I only mentioned our three largest sources of oil, the list doesn't get much better. Rounding out the 4th and 5th spots on that list are Venezuela and Nigeria. Again, lower crude prices will make it extremely difficult to develop Venezuela's heavy oil deposits. I am confident my readers understand the volatility associated with Nigeria. The thought of working on a rig over there makes me shiver.

Drilling the Williston Basin

So where does that leave us?

I'll admit it's difficult to get behind our domestic production. Despite the doom and gloom that dominates most U.S. production outlooks, there is one shining star on the horizon.

Stretching across North Dakota, Montana, South Dakota, and southern Saskatchewan is the Williston Basin. And as many of you are aware, the Williston Basin is home to the Bakken formation. Unlike many other areas in the U.S., the Bakken still has quite a bit of potential. In fact, it's one of the few areas where production is actually expected to increase.

Don't get me wrong, dear reader. This deposit isn't going to save the U.S. from peak oil. It's not the panacea for U.S. production.

If oil is able to find support and remain over $50, the solid players in the Williston Basin will prove extremely profitable for investors. Like the rest of the industry, you can still pick up many of the good drillers at an extreme discount. The good part is that it's not just U.S. companies getting in on the action. Stay tuned because next week I'll show you some of my favorite plays operating on the other side of the Bakken.

Until next time,

Keith Kohl

Energy and Capital

P.S. The way I see it, there are two types of investors during a financial crisis. Either you're the kind who loses his shirt through panic selling, or you take advantage of the chaos and profit. I know which category my readers and I fall into, but it wouldn't be fair if I didn't offer you the same chance.

You see, the Pure Energy Trader was designed to make sure your energy investments come through this economic turmoil unscathed. My colleague, Ian Cooper, is on the verge of picking up another round of profits. If you're interested, I suggest checking out the Pure Energy Trader for yourself.