You may not remember this, but in the early 2000s — in the aftermath of the dot-com bust — the price of crude oil dropped to $12 a barrel… before going on an epic ramp-up to $147 in the summer of 2008.
The question everyone asked was, "Why did the price of oil climb so high, so fast?"
The answers are obvious: emerging market demand, global liquidity bubble, a falling dollar, and decelerating production.
In other words, the Chinese are buying cars; people used their house as an ATM to buy SUVs; the currency printing presses ran in overdrive; and ExxonMobile ran out of cheap, easy to find oil.
But while that much is clear, what’s not so easy to understand is why — after a brief dip a year ago into the $30 range propagated by margin calls on hedge funds — the price of oil has bounced back with surprising strength.
When the entire global economy experienced the biggest recession since the 1930s, why is that that the price of oil — a cyclical commodity that is directly tied to the boom-bust cycle — still at $80 a barrel instead of $15?
The first reason is demand…
The ISM Manufacturing Index came back with surprising virility. After falling from 50 in January of 2008, it fell to 33 in November of that same year. Today, it’s around 57 and in fact above its 2007 highs.
China Still Buying Cars
Another reason is that emerging markets are buying even more autos. Last month, China set another record for auto sales.
According to the Wall Street Journal: "Taken together, auto sales in January and February rose 83.8% from a year earlier to 2.88 million… China remains a bright spot for auto makers as they try to regain their footing in developed markets. China became the world’s largest auto market last year, overtaking the U.S., which faced record sales drops amid the global financial crisis and the solvency problems of its top car makers."
The behemoth buys in American are also continuing.
SUV Sales
No one ever went broke by overestimating the buying power of the American consumer — especially if you invested in Ford (NYSE: F), which went from $1.81 to $13.04 this year. Ford has topped GM as the new leader in U.S. car sales, selling 142,285 vehicles last month.
And while car sales rose 54%, truck sales rose 36% compared to a year ago. Despite what the media would have you believe, this country still loves trucks and will continue to buy them.
No More "Home as an ATM"
The days of taking cash out of houses en masse has ended. In the last month, refinancing applications decreased 1.5%… Lenders have increased fees that make the numbers difficult despite low interest rates… And there is the ever-present fact of real estate being "under water." We should start calling it coral or something.
The Treasury Continues to Print
Though it don’t exactly "print" dollars anymore, the Fed has bought $1.75 trillion worth of debt last year. I envision a bald-headed flack in a back office adding zeros to the national debt via on a laptop… peck, peck, peck…
According to Barron’s, "The Fed’s massive securities purchases have effectively doubled the size of its balance sheet." Though the official CPI remains under 3%, it seems obvious that we will be looking at a higher inflation rate in the future, and this will push hard assets higher.
Reserve Replacement
Big non-national oil companies are having a hard time finding reserve replacements. This would suggest that all of the easy oil has been found. I’ll give you an example: Chevron Corps exploration failure rate jumped to 35 percent last year from 10 percent in 2008. ExxonMobile bought XTO Energy for $29 billion, a natural gas producer. According to Frost Investment Advisors in Houston, "[oil majors] are looking at a higher initial investment and a relatively more-muted return on invested capital relative to what you were to find 10 or 20 years ago."
BusinessWeek reports, "ConocoPhillips forecast that its output will drop 2.7 percent this year as Chief Executive Officer Jim Mulva seeks to sell $10 billion in assets. The company’s exploration failure rate rose to 43 percent last year from 32 percent in 2008."
The upshot of all of this is that the oil majors are taking on new risks, switching from crude to natural gas and doing anything they can to find energy to sell.
At the same time, China and other emerging markets continue to buy cars and other energy using appliances as their standard of living grows. As the business cycle climbs off the bottom, more people will go back to work and energy usage will continue to increase. And the ever present boogie-man of too many dollars (euros, pesos, yen, and so on) chasing too few goods will lead to global inflation.
This means that despite the housing slump, hard assets like oil will continue to do well going forward.
Buy Small Oil Companies with Large Discoveries
I’ve made a living off of buying small oil companies that go to unusual places, take on some risk, and find big puddles of oil. One such company is Tullow Oil (TLW.L):
I last recommended Tullow Oil, a London company, in November of 2008 at 435 pence. Today it is trading at 1,277 pence.
The company made a major oil discovery in Africa. The company recently cashed in by selling a third of its assets in Uganda to Total SA of France and CNOOC Ltd. of China.
A few months ago, I discovered an even better stock located on the Chinese border of Mongolia. This company has more than 612 million barrels of probable reserves and yet trades at only 30 pence per share ($65 million market cap). It’s a small, little known company that is crazy undervalued.
It is my favorite stock this year. It is already up 62% in the past month — and this is on top of the 57% gain in a few days on eBay calls, and up to 313% an undervalued biotech in about five weeks.
I just go this note this morning on the eBay calls:
Hi Christian:
I actually got in at .34 and out at .58, and I am absolutely amazed by your prowess. I saw them at .74 for a while one day and I couldn’t believe my eyes, so I waited (like a fool — won’t do that again!). Options are scary and mysterious for me, but I am following you around like a puppy. Thank you so much.
Christian, I also have to say I appreciate your optimism and your advice. I wrote a note down by my computer thus: "Christian says to not do anything for a month" — you don’t know how reassuring that was to a fraidy-cat like myself. My next step is to get an international broker to do some of your other trades.— Jennifer D.
No one knows for sure when oil will hit $150 a barrel, but all the data is pointing to a higher price. The economy is coming back. The Chinese will continue to expand, and the majors will continue to make acquisitions.
The best way to play it is to buy small companies — in out-of-the-way places — that are sitting on lots of oil. I’ve found the perfect company with a clear catalyst in April. You can read my free report here.
Christian DeHaemer
Editor, Energy and Capital
Editor and Founder, Crisis & Opportunity
