Oil prices recently hit 12-year highs. Heating oil hit an all time high, natural gas prices continue to stay firm and gasoline is certain to set a new record this summer. How high will prices go? Unfortunately, I do not have an answer to this question and would be very suspicious of any “market expert” who claims to have such knowledge. The more important question investors should be asking themselves is, what effect will these high prices have on my portfolio?

The disconnect between high oil prices and energy equities is unbelievable. With the price of oil and gas at such high levels, one would think that oil and gas equities would gain the investment world’s attention. However this is not the case. The following quote was taken from an article titled “Real Returns” by Gene Epstein that appeared in the March 3, 2003 issue of Barron’s:

“…oil stocks--especially the big integrated oil majors like BP, Royal Dutch Petroleum and ChevronTexaco--trade near six year lows while offering solid dividend yields clustered around 4%.”

While I do not particularly like the investment prospects of the major integrated oil companies, I feel they deserve some respect. The US major integrated oil companies are woefully undervalued given their earning power and their dividend yields, which are more than 10-year US Treasury notes. The US majors are not the only group seeing declining stock prices in an environment of high commodity prices. The AMEX XNG Index, an index of 15 large natural gas producers, has dropped 16% from 3/15/2002 to 3/14/2003 despite a 63% rise in NYMEX natural gas prices. The Toronto Stock Exchange Energy Producer’s Index has dropped 4.5% in the past year despite a 39% rise in AECO natural gas prices and a 52% rise in the price of Edmonton Light oil. I see only one reason for the huge disconnect between commodity prices and equity prices: investment inertia.

charts courtesy of www.stockcharts.com 

Investment inertia is simply the belief that past events will continue to repeat themselves in the future despite overwhelming evidence that the fundamentals that supported the investment theme no longer exist. As discussed in the inaugural issue of the Canadian Energy Viewpoint (October 2002), George Soros might refer to a wide scale case of investment inertia a “reflection point.”

The investment inertia being committed by Wall Street and many market observers is atrocious. The belief that oil is going back to $20 a barrel shows a clear lack of understanding of the dynamics of the energy world. As I have outlined in previous issues,  the supply/demand fundamentals of the oil and natural gas market have dramatically improved in the past two years and will continue to do so for years to come. Do not let Wall Street fool you into believing we will return to the 1990s pricing model where oil stayed near $18US a barrel for much of the decade and gas floundered under $2.00 per million cubic feet for years at a time.  Much of the reason Wall Street does not want to admit that we are in an era of high oil and gas prices is the negative effect this would have on stock prices in general. Remember, the same Wall Street investment firms who are predicting a significant pullback in the price of oil, once pumped dot-coms, media, telecom and technology stocks despite overwhelming evidence of significant problems in these areas. They repeatedly gave the standard response of, “we did not see it coming” in blow up after blow up.

Marc Faber, PhD is widely regarded as one of the greatest investors of our time. He is a remarkable gentleman who is often referred to as “Dr. Doom” due to his often bearish yet very prophetic investment positions. (For more information on Dr. Faber, visit his website at www.gloomboomdoom.com). Dr. Faber is very bullish on oil and has predicted that demand from Asia will drive prices significantly higher than today’s levels. Dr. Faber recently completed an outstanding book, entitled “Tomorrow’s Gold: Asia’s age of discovery,” in which he discusses not only investing in Asia, but also investor psychology. The following quote about a perceived lack of investment themes fits perfectly with today’s markets:

“I have studied all of the major investment themes of the last 30 years – including gold, oil and gas and foreign currencies in the 1970’s, Japanese stocks in the 1980’s, emerging markets between 1985 and 1997, and US equities in the 1990’s. In each case, investors were extremely slow to recognize the new major theme. They were too slow – to their detriment – to understand that the investment game is ever changing, requiring them to abandon the obvious and move to a totally new sector.” “Tomorrow’s Gold, Asia’s Age of Discovery,” Marc Faber, 2003, page 11.

While the investment herd complains about a lack of investment themes or trends in today’s equity markets, I see a big trend. I believe oil and gas investing, especially Canadian E&P equities, will be the next major theme to be recognized by the investment community. Given the outstanding earnings that virtually every North American E&P firm will post in Q1, it is difficult to believe that the facts can be ignored much longer. I suggest readers take a close look at their portfolios and determine if they have sufficient exposure to the coming boom in E&P equities.

While I do not want to belabor the point that the investment community has not caught on to the energy investing theme, I would like offer one final bit a proof. The amount of assets in ten of the largest energy directed mutual funds in the United States is a combined $1.1US billion. This is a pittance. The table on the left was found on page F5 of the March 3, 2003 Barron’s

While there are a few other energy directed mutual funds that did not make it into the table, I believe the above table clearly illustrates the under representation of energy in the mutual fund world. Lack of assets in energy mutual funds, combined with the fundamentals of this sector, should be seen by investors as an excellent contrarian signal that energy is the right place to be investing.

ADDITIONAL NOTES from Bill Powers

OPEC…What a Charade!

The early March meeting of OPEC ministers in Austria was an absolute farce. Despite pronouncements to the contrary, there is nothing OPEC member countries can do to alleviate supply shortages since every OPEC country, including Saudi Arabia, is producing at maximum capacity. The only reason for the meeting was to help OPEC extract extra dollars from oil importing nations. As long as the Western world believes that high oil prices are due the war with Iraq and not the result of supply and demand fundamentals, OPEC is more than willing to play along. The myth that OPEC can actually increase production will keep the majors from increasing their exploration budgets and our political leaders from realizing that we are experiencing an energy crisis that is growing worse by the day. 

At War with Iraq

On March 17^th,  President George Bush made a historic speech to the world declaring that the time for diplomacy with Iraq has ended. He gave Saddam Hussein 48 hours to leave his country. The following day, oil markets around the world continued their several day decline as oil prices touched multi-month lows in the spot and future markets. It appears many traders on the NYMEX felt that war would eliminate any war premium and return crude to more normal price levels. I find this view ridiculous. War is likely to make an already tight supply situation even worse. For example,  Reuters reported that shipments of crude from Iraqi ports have halted indefinitely due to banks’ refusal to guarantee loans to transportation companies.  The resulting inability to transport 1 million barrels via tankers comes on top of the estimated 1 million barrels that cannot be transported through Jordan and Syria to the black market. In addition, there is decreased production in Kuwait due to the hostile environment.

One of the many ironies that will emerge from the war with Iraq is the fact that the stoppage of Iraqi exports is likely to be felt more in the US than in any other country. According to the US Commerce Department, the US is the largest importer of Iraqi crude and in January depended on Iraq for 17.1 million barrels of crude, or 6.4% of total imports. Since it takes about 45 days for tankers to reach New Jersey from the Middle East, look for very tight supplies, or even shortages, of crude as refineries ramp up production of gasoline for the summer driving season.

© 2003 Bill Powers, Editor
Canadian Energy Viewpoint
See Mr. Powers' Cover Page for Bio and Archived Editorials

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Bill Powers
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Information presented in this newsletter was obtained from sources believed to be reliable, but accuracy and completeness and opinions based on this information are not guaranteed. Under no circumstances is this an offer to sell or a solicitation to buy securities suggested herein. The editor may have an interest in the companies mentioned. All data and information and opinions expressed are subject to change without notice.