Oil Prices: Two Ways to Profit From ‘Peak Oil’

June 18, 2010

By Peter Krauth, Contributing Editor, Money Morning

If there's one thing U.S. investors need to know about the future, it's this: Oil prices are headed higher - much higher, in fact, and could well double to reach $150 a barrel.

And if that's what the future holds, you may as well go along for the ride...

U.S. oil prices fell for the first time in four days yesterday (Thursday) - ending a rally that had taken crude prices to a six-week high. Crude oil for July delivery now stands at roughly $77 a barrel, meaning oil prices would need to nearly double to hit my target of $150 a barrel.

But I think that can happen - and here's why.

A Wakeup CallAmerica is about to get a sobering slap in the face.

And that slap will have to do with the country's passive, unimaginative and downright-haphazard national energy plan.

Under U.S. President Barack Obama, it seemed as if the United States was finally going to create the innovative, broad-based and forward-looking energy policy that this country has badly needed for decades.

Then along came BP PLC (NYSE ADR: BP), and the Deepwater Horizon oil spill that now threatens the Gulf of Mexico ecology and the entire U.S. economy. Now the villager pitchforks are all pointing at BP for that mammoth oil spill - instead of at the Inside-the-Beltway crowd as a way of "motivating" them to re-cast the energy policy to account for the BP disaster.

Did BP mismanage this fiasco? That's a pretty safe bet.

Is offshore oil drilling about to suffer a major kick in the pants? It definitely seems so.

I'm not expecting any new offshore drilling for some time: Public sentiment has swung way against offshore exploration, and I expect the government to seriously ramp up oversight.

U.S. consumers flat out take oil - and energy in general - for granted: The lights come on at home or at work when we flip the switch; the pumps are full when we pull up to the gas station; and oil and energy are still pretty cheap... at least, for now.

But Americans need to realize that "demand" is evolving. Other countries around the world are looking to improve their standards of living. And based on the technologies now available, such upgrades require oil - lots of it, in fact. Oil influences so many facets of our daily lives: Transportation, energy, consumer goods, packaging ... the list is long. And given our current plight, that list is also sobering.

I know, I know, we may only now be emerging from a deep recession, Europe's got big problems, and we could experience a slowdown in growth for Asian economies. But despite this, oil consumption is still rising. And America remains a big part of global demand.

America' Appetite for Oil
The United States consumes 20 million barrels daily. That's more than the next-five-largest consumers - China, Japan, Russia, Germany, and India - combined. Of those 20 million barrels, 56% are imported. The imports alone represent more oil than Saudi Arabia produces in a day; in fact, it accounts for nearly 20% of the world's entire production.

Meanwhile, America's own oil is drying up. The Gulf spill - and the accompanying ban on offshore drilling - will only exacerbate the shortfall that's sure to escalate.

Even with all the exploration dollars and the most advanced exploration technologies available, the United States' oil-production numbers have been heading south for 40 years.

Sure, there have been ongoing discoveries, but too few, and none of the size required to stem the nation's growing dependence on foreign oil.

Last November the IEA (International Energy Agency) reported that oil production from operating wells has declined by as much as 9.1% annually. Then in March, the U.S. Department of Energy (DoE) indicated that if investment is insufficient, there could be worldwide declines in liquid fuels production starting next year and stretching to 2015.

But relax. According to the U.S. Department of Energy (DOE), the concept of "peak oil" is, well, bunk.

Feeling reassured now? Me neither. And here's what's bothering me...

Slick Contradictions

Last April, in the aptly titled report, "Meeting the World's Demand for Liquid Fuels, that same DOE projected stable increases in fossil fuel production all the way to 2030. How anyone can forecast 20 years into the future with a straight face baffles my mind.

Stay with me here, because that same DOE, in that same report, acknowledges that it doesn't know where this additional production will be sourced. Their report goes on to indicate that current and known oil production sources will start to decline within just two years.

It would seem the government believes that the expected daily shortfall of an estimated 10 million barrels of crude (again, nearly all the oil the Saudis produce) will just be "wished" into production.

That makes it my turn for making a prediction. And it's one that I'm pretty confident about making: I don't expect anyone to find another Saudi Arabia's worth of oil anytime soon, much less get it into production by 2012. But maybe that's just me.

And when producers are able to fetch $100 per barrel, there's little incentive to boost production and drive prices back down. Instead, this allows them to maximize profits, even as they extend reserves. That's just shrewd business strategy for those producers.

Plus, with so much oil controlled by national governments - Saudi Arabia, Iran, Libya, Algeria, Venezuela, Nigeria, Russia and Mexico, for example - years of severe mismanagement and under-investment bode badly for supply, but bode well for significantly higher prices.

A Pair of Plays on Higher Oil Prices
I don't see any major production increases anywhere on the horizon, yet demand shows no real signs of easing. Therefore, the only thing left for us to do is to position ourselves for maximum profit.

After reviewing a number of energy-related companies, securities and funds, I decided on two that offer the right mix of such factors as upside potential, liquidity, safety and timeliness.

Those two oil-related investments consist of:
Apache Corp. (NYSE: APA): This is an explorer/producer of oil, natural gas and natural-gas liquids. It's a $30 billion market-cap company, trades at a palatable Price/Earnings (P/E) ratio of 14, and it pays a small dividend. The company explores and operates in the Gulf of Mexico, Texas, the Anadarko Basin, Canada's Western Sedimentary Basin, onshore Egypt, offshore Western Australia, in the North Sea (off the coast of the United Kingdom) and in Argentina and Chile. I like the geographical mix, as well as the commodity mix, which breaks down as 51% oil and liquids, 28% North American Gas, and 21% international gas. The BP Gulf oil spill seems to have exaggerated recent price weakness for Apache. At the time of this writing, Apache's shares were trading about 12% below the 200-day moving average and heading north. Apache makes a great long term "Buy."
First Trust ISE - Revere Natural Gas Exchange-Traded Fund (NYSE: FCG): This is an ETF that tracks the performance of a basket of companies that are focused chiefly on natural gas exploration and production. The United States needs to continue emphasizing its own energy resources, especially resources of the-more-environmentally-friendly variety. Natural gas clearly fits that bill, and the stuff is relatively cheap at around $4.80 per million British thermal units (MMBtu). This ETF's holdings include such heavyweights as Mariner Energy Inc. (NYSE: ME), Brigham Exploration Co. (Nasdaq: BEXP), Pioneer Natural Resources Co. (NYSE: PXD), Forest Oil Corp. (NYSE: FST), EOG Resources Inc. (NYSE: EOG), and Anadarko Petroleum Corp. (NYSE: APC). The fund is currently trading below its 200-day moving average and its share price also is trending higher. So the FCG ETF is a clear "Buy" at current levels.
Sure, it would be nice to just move to renewable pollution-free fuels, but that's decades away - if ever. Besides, many technologies can't be converted, so as long as they're in use, oil will have to fuel them.

If the picture of the future I've painted here is one that's causing angst, or even fear, that's probably not a bad thing: This is the future I believe we're going to have to face.

My advice: Get used to it, and get ready for it. Oil is going higher. You might as well go along for the ride.

[Editor's Note: Prussian military theorist Carl von Clausewitz once said that "the best defense is a good offense." That adage has since been applied to many fields of endeavor - from combat to football.

It's also great investing advice - especially with such commodities as gold.

Historically speaking, commodities-related investments were superb defensive plays - particularly during periods of great uncertainty.

That's still the case.

But now, with the emergence of Asian powerhouses such as China, projected declines in global supplies, and the current debt fallout from the global financial crisis, hard assets and commodities such as gold are also the most-promising profit opportunity in the financial markets today.