Stocks - June 2008

Peak Oil! Part II In a previous column titled “Peak Oil!”, I described the basis for the theory that states the limitations of the world’s ability to produce oil and bring it to market. There is still oil out there, and the world isn’t running out; however, it’s difficult to reach, and there’s no longer unlimited access to cheap oil. Much of it is trapped in unconventional sources, hostile terrain, owned by sovereign governments, or politically off-limits for production (Arctic National Wildlife Refuge, and basically all of the coastal waters of the United States, excluding the Gulf of Mexico). In order for oil companies to find useful and economic quantities of new oil and gas for our needs in this new reality, it requires a great deal more technology, assumed risk and quite frankly, money. It simply costs a fortune to find, develop and produce a meaningful new discovery — if the companies are even allowed to do so at all.

Which brings us to back to Peak Oil. Like any of you, I am stunned by the prices at the gas pump. It’s painful to fill up my car. So many friends and acquaintances feel the same, judging by the stunned looks anytime the subject comes up. Everyone wants to know: will gasoline ever again be cheap?

Probably not.

Although many blame today’s high prices on the falling dollar and rank speculation in the energy markets, that’s not the entire story. Quite simply, in large part, world demand for oil has caught up with available supply and sovereign nations without indigenous reserves are now in a bidding war for dwindling exports. Expect prices to remain high.

The recent history of Cheniere Energy highlights what can happen in a worldwide bidding war for energy. Cheniere Energy (AMEX: LNG) is in the business of developing, building and operating onshore liquefied natural gas receiving terminals, several of which are located right here in Louisiana. Take a look at the accompanying one-year stock chart for Cheniere Energy — it’s a disaster.

Here’s why. While the price of natural gas here is roughly $11 per thousand cubic feet (MCF), that’s not the case elsewhere. Japan is one of the places willing to pay more, and that’s exactly what’s happening right now. Japan has recently been bidding upwards of $18 per MCF for LNG. China also has been paying such prices. The primary reason why the stock of Cheniere Energy has collapsed is that many tankers full of LNG formerly headed for Cheniere’s facilities are now routed to higher bidders in Asia. Cheniere just isn’t as busy as it used to be. The world has changed. If you want to buy oil or gas from foreign producers, you have to pay for it. And the world market demand sets the price.  If you give credence to the theory of Peak Oil, then the implications are enormous. First, not only is it unlikely that gasoline prices will fall back significantly for any extended period, but there may well come a time when we look back and wistfully recall the good old days of $4-a-gallon gasoline.

If that happens, there are a number of investment and lifestyle implications. First off, be thankful you’re not an airline. They offer a commodity product (nothing really to differentiate their service from a competitor, so there is no unique pricing power) and have absolutely no control over costs. They’re really in a bind. Expect a dramatic consolidation in the airline industry, fewer flights and higher ticket costs for those carriers that somehow survive. I have no interest in owning airline stocks.

With diesel now comfortably above $4 per gallon, long-haul truckers will continue to have an uphill battle to remain profitable — which shines a new light on railroads. Trains move freight at far less cost per ton than any truck possibly can (on average, freight railroads move a ton of freight 423 miles for each gallon of fuel). High fuel prices have given freight railroads a new lease on life, and their future is bright.

Obviously, some automotive companies have geared themselves toward a high fuel-cost world. Carmakers that have been on the vanguard of the smaller, hybrid vehicles should continue to gain market share at the expense of those who didn’t anticipate changing market conditions.

High energy costs will also affect where we choose to live. The smaller communities that have many amenities and needs within close proximity to home should become all the more attractive. Be glad not to be a long-haul commuter living in Houston or Los Angeles.

Finally, the synthetic oil industry (a process that turns coal into liquid hydrocarbons) appears to have an extremely bright future. There are a number of publicly traded companies actively engaged in this area of the energy business. While the cost of producing synthetic oil is currently high, mass production and the economics of scale have the potential to lower prices nicely. With our enormous reserves of coal, synthetic oil is, in my opinion, a get-out-of-jail-free card. And we sure look like we could use one of those right now.

Bo Billeaud has been president and chief investment officer of a Lafayette-based money management firm for the past 17 years. Contact him at [email protected]