I have started this thread (Part I) to discuss and talk about what I think are some very important trends (which are all related) coming to a close that investors need to be aware of. What are the best investments to make in light of these trends (or more specifically ending of these trends), and how best to diversify.
Some content may be viewed by perma Bulls as overly negative however I would prefer to keep on the constructive side and look to where best to hold capital in light of some headwinds (particularly for the US) I personally see on the horizon.
Inflection Point 1 - Peak Oil
Current Trend world oil production rising for the last 100 years
Inflection point world production Peaking between now and 2010-12
Personally I work in the investment area of energy (oil, gas, electricity) so feel reasonably comfortable about this topic. The simple fact is that most oil producing countries are currently in irreversible production decline, and once they reach that point very rarely come back to break new highs in production.
As we stand now Saudi Arabia (largest oil exporter) claims to have spare capacity of a few million b/d and is withholding from the market to keep prices generally stable. Currently Saudi oil supplies between 8-9 mb/d out of a total world demand of 85 mb/d. I Dont have the figures handy but most (if not all) government and analyst energy models assume Saudi production can grow with world demand to 15 mb/d +. However many in the industry are far more sceptical, most notably Matt Simmons Investment Energy Banker, he personally attempted to audit Saudi Oil production availability and reserves in his book Twilight In the Desert (I have read). Recently Matt made the call that he believes we have passed peak oil NOW.
Implications: Peak Oil is inherently inflationary especially for countries that are net importers (ie OECD most notably the US) as it attempts to price users out of the market to reduce demand inline with supply. Note that even the UK with North sea production in decline is moving to be a net importer. How high can prices go?? no one knows, but consider that in 1999 prices were $15-20 a barrel and since then the price has more than tripled while at the same time demand has kept increasing!!
In general I would be looking for anything exposed to the price of oil increasing or that provides solutions to limit use of or substitute oil
Direct Oil Shares Preference would be for smaller players that are coming into production and do not have the large reserve replacement burden of the majors. The more risky might like to go for small explorers that have good prospects. Be careful of the fact that most oil and gas companies are facing massive cost inflation for their projects.
Oil Futures I have absolutely no experience in trading futures, so people with better experience in this area may be better to advise and how to expose yourself to rising prices. Take note that Oil demand has seasonality and as such prices will tend to fluctuate with seasonal demand in a tight market (see last few years seasonal price volatility)
Canadian Oil Royalty Trusts Someone else in the industry has mentioned to me that these provide very good exchange traded exposure to the underlying oil price. (anyone have any info??)
Rail 70% of oil demand comes from transportation and rail is the most energy efficient way from moving bulk goods from A to B . anyone else notice where W.Buffets largest investments have gone lately?
Oil and Energy Service Companies The amount of capital investment large oil companies are making at the moment is absolutely staggering, just to keep their production rates flat! The basic premise is all the easy oil is gone and the investment to get that oil out was relatively small compared to what investment will be needed to keep production rates high for as long as possibly (more wells, more expensive, harder to get at, more technically involved etc) all leads to a massive windfall to oil & gas service companies. Also note that most of the industries infrastructure is old and in general has been underinvested in for a long time.
Energy Substitutes (Fuel and Infrastructure) A lot of the use of oil comes from transportation, of which there are no immediate easy substitutes on a large scale. Bio diesel is a bandaid fix at best, as it has its own problems with EROEI (Enegry Return on Energy Invested) its use however will have knock on effects for food pricing. The only long term solution I believe is to move transportation on a large scale to electricity power. From here we can then diversify the energy supply for transportation to coal, gas, nuclear & renewables whichever turns out to be most cost effective. The implications of this are massive investments in the electricity infrastructure industry (generation, transmission and distribution) this again will be very inflationary in a macro sense but for the players involved will be a huge windfall, the scale of infrastructure needed will be in multiples of billions.
As to the fuel that is ultimately used, I think picking a winner will be hard, but the macro trend is that all substitute fuels will be winners (fossil and renewable). My general observations from what is happening in the market is that coal is coming back in a big way and we will have to find some way to deal with the CO2. I am pretty certain that someone at some point will crack the renewables game on a baseload scale but predicting when how and if this happens is a mugs game in the short term we will find the cheapest solution which buys time.
Risks: Oil price rises are not a one way bet. Recent strength has relied on robust demand that would falter if a world recession were to eventuate. However I believe in all probability a new supply source will not be easily found and any weakness should be seen as a buy on long term fundamentals not changing.