Three Stocks for the Coming Oil Shortage

12/08/2009 9:31 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

There's oil aplenty in the short term, but the savvy investor will look at the energy crisis that appears to be lurking in the future—and act accordingly.

Devon Energy's decision to sell its expensive-to-develop deepwater assets in the Gulf of Mexico in order to concentrate on its onshore natural gas reserves makes perfect sense.

For that one company.

For the oil industry, and for the global economy, it could make the predicted energy crisis of 2015 or so that much worse.

In the short term, there's plenty of oil. The slowdown in the global economy and the addition of supplies from countries such as Angola ensure that. The Organization of Petroleum Exporting Countries (OPEC) has a sizable surplus of production capacity.

In the long term, the story is very different. By, say, 2030, oil could face a serious shortage. And that shortage might happen much sooner because of perfectly reasonable decisions by individual oil companies to maximize their profits. Maybe as soon as 2015.

If you are a genuinely long-term investor, I've got a few stocks to suggest for how to profit from what is admittedly a distant trend. Even if you're not interested in putting money to work on prospects that are several years away, I think knowing about this trend will give you potentially profitable context for all your investments.

A Completely Logical Move

In my December 1 column, I explained the logic of Devon Energy's decision to sell its promising Gulf of Mexico deepwater and international assets and concentrate on producing more natural gas from its huge reserves in the US—even though there is a glut of natural gas on the US market right now.

The decision comes down to cost and time. Exploration and development costs for the onshore North American wells are roughly $6.86 a barrel of oil equivalent, Deutsche Bank has calculated. Working backward from the Deutsche Bank figures, I estimate Devon's exploration and development costs for the assets it want to sell at $31.13 a barrel.

The result was a situation in which the "tail" of Gulf of Mexico and international assets wagged the dog. These assets have eaten up 29% of the company's capital spending in 2009, but equaled just 7% of the company's proven reserves of 2.8 billion barrels of oil equivalent. For the year, they'll contribute just 11% to the company's estimated 248 million barrels of production.

The payback on these new deepwater or overseas fields is painfully slow. Investments in developing such fields can take five years before they generate significant cash flow. In contrast, drilling wells in existing natural gas fields in the US produces cash flow within months.

So Devon's decision about the Gulf assets is completely logical.

But follow out the consequences of that logical decision if it is adopted by more companies than just Devon. You'd have oil companies around the world abandoning expensive-to-develop, long-lead-time oil projects and concentrating instead on cheap-to-develop, shorter-lead-time oil and natural gas projects.

That seems to be what has happened in the energy industry, especially the part of the industry inhabited by the investor-owned, publicly traded international oil majors. In this shift, Devon Energy isn't a pioneer. The company is, in fact, following a path conspicuously traveled by Exxon Mobil and other bigger companies.

Take a look at the breakdown in Exxon Mobil's 2008 annual report of the 120 projects under way that are forecast to produce 24 billion oil-equivalent barrels. The pie chart is dominated by the kind of projects that Devon Energy announced it would focus on after selling off its international and deepwater Gulf of Mexico assets. By far, the biggest category for projects is liquefied natural gas. Alone that makes up about 25% of Exxon's projects. Add in unconventional gas (such as the Barnett Shale that Devon owns so much of), acid and sour gas, and heavy oil/oil sands and you've accounted for roughly 75% of all the company's projects. Conventional oil and gas, deepwater oil and gas, and Arctic oil and gas add up to just 25%.

There are lots of good reasons for this emphasis. National governments with big undeveloped oil reserves have largely frozen out the international majors. Liquefied natural gas looked like a rapidly growing—and underdeveloped—market years ago, when many of these projects were launched. Nobody predicted today's natural gas glut. (For more on the glut, its causes, and when it might be over, see this recent post.) And all these projects—yes, even oil sands—are more predictable in their results (although not always cheaper, as in the case of oil sands) than searching for oil in the Arctic or deeper and deeper deepwater.

Like it or Not, We Need Oil

But even though Exxon Mobil's emphasis—along with Devon's and other companies'—is reasonable, understandable, and logical, it still creates a global problem not too far down the road. You see, with current technologies—and with new technologies that look like they can go mass market in the next ten years— natural gas and oil aren't fungible. We can't now run cars, trucks, and the bulk of our decentralized transportation system on natural gas. We need oil.

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And although the presence of natural gas-powered buses rolling past my window in New York City says it is certainly feasible to power a vehicle on natural gas, the lead time and expense for building out a natural gas supply infrastructure (in the form of natural gas refilling stations, or in the form of electric recharging stations supplying electricity produced from natural gas) argue that we're looking at far longer than ten years to move a significant portion of the global vehicles fleet away from oil.

The International Energy Agency projects that the world will use 105 million barrels of oil a day by 2030. That's a huge 20 million barrels a day above current global consumption.

If that's too far out for you, the agency estimates that if oil consumption grows by just 1.4% a year, by 2014, global oil consumption will top 89 million barrels a day, about four million barrels a day above current levels of consumption.

That wouldn't be so much of an issue, except that growth in global oil supply is slowing for reasons that range from the difficulty of finding oil, to financial constraints due to the Great Recession, to moves like those by Exxon Mobil and Devon.

In June, the International Energy Agency cut its forecast for oil supply capacity growth during 2008-2014 to four million barrels a day. That would still match the projected increase in global oil consumption over that period.

But I have to wonder how long that demand/supply equilibrium will last. The agency's June forecast was for 1.5 million barrels a day of supply capacity less than the agency had projected in June 2008.

And in a wonderful piece of bureaucratic prose, the agency said supply could be lower still "were upstream spending curbs to extend beyond 2009."

There are no guarantees to any of this. The forecasts for both supply and demand that far out are so dependent on changes in the global economy, politics in the Middle East, and the cost of capital that they are really little more than educated guesses.

But I'm willing to back an educated long-term guess when I'm not likely to lose in the short term, no matter how the long term comes out. In the near term, oil and gas stocks are a good investment as global demand recovers from the Great Recession. (Although not in the extreme short term, perhaps, where the energy sector looks like it might be headed for a dip.) Making a long-term bet in a sector with the wind already at its back just adds a bit of wind speed to the trend.

How to play this long-term supply shortage is a puzzle, though. If you think the shortage is limited to oil, you can't just buy any oil and natural gas producer, because a good many of them are emphasizing growth in natural gas supply and de-emphasizing growth in oil supply.

But I can think of a few that are bucking the trend and would be good candidates for making a long-term bet on a return of an oil shortage:

  • Apache (NYSE: APA) - About 50% of the company's production consists of oil or natural gas liquid (liquids that flow with natural gas out of the well and can be converted into oil-like liquids). But the long-term story, the reason the stock is in my long-term Jubak Picks 50 Portfolio, is the company's expertise in getting more oil out of older fields that the big majors have given up on.

  • EOG Resources (NYSE: EOG) - Primarily known as a North American natural gas player, the company has been quietly buying up leases in areas where it believes that its expertise in horizontal drilling and completion give it the ability to access major oil reserves. By the end of the decade, the company, which now derives 84% of its revenue from natural gas, is projected to have moved to 50% oil and natural gas liquids.

  • Petrobras (NYSE: PBR) - The Brazilian national oil company has discovered major new oil reserves in the South Atlantic. With the development of these fields a key to gaining Brazil more clout in the world, mere cost-benefit analysis isn't going to stop the development of these oil resources.

I'd wait on all of these until what seems to be shaping up as a correction in energy stocks runs its course.

At the time of publication, Jim Jubak owned shares of the following companies mentioned in this column: Apache, Devon Energy, and Petrobras.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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