One of the threats from peak oil is the potential for financial ruin as oil prices run up. If you were invested in airline or automotive stocks through the recent run up in oil prices, you have probably seen those investments lose a lot of value. If, on the other hand, you were invested in oil futures, oil companies, or oil field service companies – you have probably seen those investments gain ground even as the overall stock market slumped. The idea of profiting from the peak – an event that is likely to cause misery for those who are least prepared – may seem an odd combination. It almost feels like “Profit from Homelessness.” But the reality is that unless you understand how energy prices affect the prospects of various sectors, you are placing yourself at a financial disadvantage.
Thus Profit from the Peak – the new book co-authored by my friend Chris Nelder – was destined to spark a lot of interest. Chris and I agree on most things energy-related, but we do also have some areas of sharp disagreement. In this review, I will explain what I liked about the book, but I will also detail my differences. Consider this a partial review, and a partial commentary on some of the particular topics in the book. Do not consider my comments as investment advice.
First off, The Oil Drum was referenced a great many times in the book. The work from many of the regular contributors was featured in the book. The first chapter was an introduction to peak oil, and it argued that peak oil is upon us. The information in the first chapter will bring a person up to speed on the potential problems we are going to experience from peak oil, but it also provides background information such as how oil is formed and subsequently refined.
Moving on to Chapter 2, the book gives a good explanation of oil depletion, and provides a nice overview of the major oil producing countries. But it also brings up the first area of disagreement that I had with the book – and that is valuation of oil companies. As the book states when talking about investing in blue chip oil companies, “we wouldn’t touch most of them with a five-mile drilling rod.” I have a different opinion.
Theirs is not an unusual argument: Oil companies are seeing their reserves and production rates decrease, and therefore their stock values are bound to follow. But let’s consider the case in which a company sees a 5% drop in their oil production rate, and yet the price of the remaining oil they are producing increases by 50%. This is not too far off the mark from what we have seen happen. What has been happening – and what I think will continue to happen – is that prices will rise faster than production rates will drop. That means that the value of an oil company’s reserves will increase year after year, even as their production rates decline. The argument that oil companies won’t weather peak oil very well discounts (or ignores) this.
Consider the case of ConocoPhillips (COP). Full disclosure, ConocoPhillips was my previous employer, and I am still a stockholder. Here’s why I still own COP, and will for the long haul. According to the 2007 annual report for COP (you can download it here), proved reserves at year-end 2007 were 10.6 billion barrels of oil equivalent (BOE), down 5.4% from 11.2 billion BOE at year end 2006 (this, primarily a result of the exit from Venezuela). At the end of 2006, the world average crude oil price was $55.95. At the end of 2007, the world average crude price was $89.76 – up 60% over year end 2006. Today, the world average crude price is $126.06 – up 125% over year end 2006.
Thus the value of COP’s oil reserves has more than doubled in the past year and a half, even though production has fallen by a little over 5%. (Note that this comparison is approximate, as the majority, but not all, of the BOEs are from oil). Further, the total value of COP reserves at today’s average crude price is $1.3 trillion – and I think prices are going higher in the long-term. The market cap for COP is about 1/10th of that at $142 billion. The market is seriously discounting the run-up in prices when evaluating oil companies like COP. Each $1 gain in crude prices increases the underlying value of COP’s reserves by $10 billion. Yet you could buy COP a year ago – with oil trading at $60/bbl, for only 20% less than the current price. Investors must expect that oil prices will fall back to the $80 range.
However, there are two caveats to consider when evaluating oil companies. One is that governments are bound to intervene as oil company profits continue to rise. If oil goes to $200 and then keeps rising – Big Oil is going to make a ton of money. Government are going to be under pressure from upset citizens to do something about this, and they will likely put various sorts of windfall profits taxes into effect. There will also be calls to nationalize, but the oil companies would likely just move to friendlier countries.
The second caveat is that the trend of falling production can’t continue forever. At some point, the oil companies are going to have to make some strategic decisions and become much more diverse in their energy offerings. But since prices have been rising faster than production is falling, they are likely to have loads of cash for getting into other energy businesses. It is admittedly an atypical investing situation – negative production growth combined with sharply higher revenue growth. But unless you think production is going to fall faster than prices will rise, I think oil companies are a pretty safe bet.
The other area that Chapter 2 missed on was the situation with refiners. While negative on Big Oil, the book was very bullish on refiners such as Tesoro (TSO) and Valero (VLO). Quoting from the book “Valero and Tesoro are going to make a pretty penny every hour they operate their refineries.” Of course that depends on one very important issue: The ability to maintain decent crack spreads. Unfortunately for pure refiners, softening demand has prevented them from increasing gasoline prices at the same rate that oil prices have gone up. As a result, refining margins have been crushed. Big Oil has the advantage of being able to absorb soft refining margins. After all, they are currently producing and selling oil for $130 a barrel. Valero, on the other hand, is buying oil for $130/bbl. As a result, in the past 12 months Valero has seen their stock fall by 40%. Over the same time period COP has seen share prices rise by 21% (and in the past 5 years, COP shares have increased by 240% – not bad for a Blue Chip).
Chapter 4 makes the case that the true cost of oil – when the negative externalities are factored in – is $480/bbl. I have only minor quibbles there, and in general agree with the overall point. I found Chapter 5 – The Pentagon Prepares for Peak Oil – to be a very interesting read. I had never really thought about it, but the book points out that the U.S. Department of Defense is consuming well over 100 million barrels of oil a year – the most of any government agency in the world. Imagine what $130 oil is doing to defense budgets. This chapter also makes the pertinent point that we have outsourced a lot of our manufacturing – and therefore our CO2 emissions – to China. Thus, it is hypocritical of us to blame the Chinese for their fast-growing carbon emissions.
Part II of the book is “Making Money from the Fossil Fuels that are Left.” This section was generally a good, fact-filled read. The information on methane hydrates was quite interesting. The book stated that the U.S. possesses methane hydrate reserves equivalent to 56 trillion barrels of oil. Of course it will be a difficult prospect to extract them commercially. This section also put oil shale claims into perspective, pointing out something that has long been apparent: Break even is a moving target, and it tends to move up along with oil prices. I have noted this for years, but I never defined it with a catchy name like the Law of Receding Horizons. Oil shale always seems to be economical at the current price plus $10-$20/bbl.
I did find inaccuracies in this section. For the layperson, most of these are trivial. But if you think about energy most of your waking hours, some of the inaccuracies will feel like an itch that needs to be scratched. For instance, on Page 96, natural gas is described as a mix of methane and propane. Propane was probably a typo, as natural gas is primarily methane and ethane. Page 109 states that ExxonMobil shelved their $15 billion LNG plant in Qatar. That was actually a proposed GTL plant. And on Page 117, the book states that diesel produced from CTL emits twice the volume of greenhouse gases as normal diesel when you burn it – and another ton of CO2 per barrel when you make it. That’s a misstatement. CTL diesel produces exactly the same CO2 emissions as normal diesel (after all, it is chemically the same as regular diesel) when you burn it. It is the production process of CTL that causes the overall carbon footprint to be so high.
There were two comments on tar sands that I disagreed with. One is on Page 127, and states that the total net energy gain is only 5 or 10%. That would make it worse than corn ethanol. Yet on Page 122, the EROI for tar sands was stated to be “as low as 5.” An EROI of 5 indicates a net energy gain of 400% (invest 1 unit, get 5 back, the net is 4 and the net gain is 400%). The second disputed argument is that tar sands must be totally dependent upon natural gas, or the construction of dozens of new nuclear plants. Thus the conclusion is that tar sands can’t scale up much. But if in fact the net energy return is 400%, the solution is easy. If you don’t have natural gas, you cannibalize and burn part of your production to drive the process. That will be an economic decision, but will become more attractive as natural gas supplies deplete and drive prices up. (Note that this isn’t an endorsement of tar sands production, as I agree with the book that there are many environmental concerns surrounding the process).
The last and final section of the book, Part III, was Energy after Oil. I particularly enjoyed the section on geothermal power, as I think this alternative option doesn’t get enough coverage. The book did a good job of clearly explaining how geothermal works, and identified some potential investments in the sector. This section also does a good job on wave and tidal energy, takes on the hydrogen economy, makes strong arguments in favor of carbon taxes, and argues that the future will be electric.
Again I found some nits to pick about the biofuels coverage. On Page 142, it is stated that biodiesel can be used as a 100% blend. However, there are no warnings about the cloud and pour point issues surrounding straight biodiesel. Try running straight biodiesel in very cold weather, and you could end up with a frozen tank of fuel. I had a few minor quibbles around the ethanol section (Despite the hype, Brazil does not get 40% of their motor fuel from ethanol!), but overall I thought Section III was the strongest section of the book.
While I found some areas of disagreement, I found the book to be enjoyable to read, and I learned a few new things that I didn’t know. Anytime I can do that, I am happy with a book. Those new to peak oil will especially get a lot of value out of the first section; those who know about peak oil will enjoy the latter parts of the book. Finally, each person will probably find that they disagree with one or more of the investment recommendations. That’s bound to any time financial advice is being offered. But you will also find lots of little companies you never heard of – but are worth investigating.
Note: I don’t consider myself to be an expert in investing. While I haven’t done too badly, my style works for me, but it may not suit you. I am a buy and hold, long-term investor. So please don’t write and ask for investment advice. I will not give it, and if you invest in a company that I mentioned in a favorable light, you are on your own.
16 thoughts on “Book Review: Profit from the Peak”
As a concept, your idea that increasing dollar value of crude mitigates the depleting reserves and COP will hold it’s value as crude price rises has a flaw.
The hard asset is the crude not the dollar value attached to it. Inflation of everything else is tied too closely to crude price and as the dollar/bbl value goes up, all that is really happening is devaluation of the dollar (inflation of everything else).
I agree that holding stock in a company with oil reserves has more real value as those reserves deplete than holding stock in an airline, when crude went from $65 to $130/bbl the real value of those fixed reserves didn’t double because everything you can buy with those “double” dollars will cost at least twice as much when the crude price hike filters through the economy. If you own a barrel of oil or a bushel of corn you have what you have, the dollar value attached to it is quickly becoming meaningless in a hyper-inflation economy.
But inflation is running far behind the run-up in crude prices. If the two were running up at the same rate, then I think your argument is valid; falling production would more than offset the run-up in prices. But in reality, oil prices have doubled in the past year, and overall inflation is up, what, 4%?
A better way of saying what I just posted:
When crude went from $65 to $130 US dollars per barrel the cost of crude didn’t rise, the real value of the US dollar was cut in half.
I posted the last re-iteration at the same time as your response, I didn’t mean it as a counter-argument.
It’s just lag and economic mumbo-jumbo. In areas like trucking and agriculture (and even oil refining as you pointed out), there is a heavy capital investment and when petroleum price rises the owners have to keep producing and take the margin loss. An independent trucker has to bid on jobs and keep the truck running, a farmer has to buy fuel and fertilizer at whatever the price is and a refiner has to buy crude and sell gas/diesel at whatever the market will bear. This goes on until they go broke and this effect lags the true inflation for a year or two.
That doesn’t mean that holding stock in companies that hold real commodities isn’t a good idea, it just means that in a resource depleting economy the dollar value attached to things doesn’t mean a lot.
Crude futures are dropping $1/bbl/hour this morning (just like they went up $1/bbl/hour on Friday), this is pretty much proof that currency is turning into Monopoly money.
Hey bob – so you aren’t too sorry to be holdng loonies now!
Personally, my assets are tied in 3 things. A home in Regina, 1/2 share in 1000 acres of Canadian farmland and a Terex crane that is manufactured in the US.
We dumped all of our mutual funds in the last year and I took the last 6 months to renovate the remaining portion of our home. Due to the housing boom and a 2 year waiting list to build a new house in Regina, the “value” of our home tripled in the last six years, but it was sitting partially reno’ed and it seemed like a smart thing to do at this point to convert mutual fund investment into home equity (plus a lot of sweat). We aren’t planning on selling at the moment, but the housing market is silly here and we were in an unsaleable 1/2 completed reno situation that is now corrected.
I got a substantially better deal on a 60 ton Terex crane last October with the CDN$ on par with the US$ than previous purchasers that had a $0.85 CDN$, which makes the current resale value strong. This is going to change if the US$ tanks and you can buy a new US built crane for even more of a discount than I got last fall with Canadian dollars. So far, so good.
Farmland is priceless and will remain so.
Would I trade any of this for COP stock regardless of the price of crude?
About biodiesel and “Try running straight biodiesel in very cold weather, and you could end up with a frozen tank of fuel.” I am kindly asiking, if You are aware on Finnish company named Neste Oil, which is making groundbreaking work with renewable energy. Their product NExBTL should pass that “frozen tank” test, if i have get it right:”Neste Oil has developed a biodiesel component NExBTL utilizing a proprietary conversion process for vegetable oils and animal fats. NExBTL Renewable diesel properties are similar to the best existing diesels such as GTL or Swedish Environmental Class 1 fuels. NExBTL is sulfur-, oxygen-, nitrogen- and aromatic free and has very high cetane number. Product meets the requirements set by EN590 and WWFC category 4 except for density.
Cold properties (cloud point) of NExBTL can be adjusted in the production from -5 … -30 ºC to meet the needs of various climatic conditions. Heating value is similar to the EN590 hydrocarbon fuel, storage stability is good and water solubility low. NExBTL diesel is compatible with the existing vehicle fleet as well as diesel fuel logistic system and is technically easy to blend in conventional diesels in all rations”. http://www.nesteoil.com/default.asp?path=1,41,539,7516,7522
For your information: I am not working for Neste Oil so this is not meant to be a free advertisement – it is just worthwhile paying attention to the latest research on biodiesels that are of high quality and can actually been taken seriously. Especially as there is a lot of confusion about what biodiesel means in different contexts. There is no one biodiesel but many differents types of it and this, I think, is of importance as there are many interest groups and lobbyists argumenting around the issue. I would be happy to get some comments and serious discussion about the matter – as my position is neutral, I do not expect you to swallow the piece of information I included as such.
While negative on Big Oil, the book was very bullish on refiners such as Tesoro (TSO) and Valero (VLO). Quoting from the book “Valero and Tesoro are going to make a pretty penny every hour they operate their refineries.”
I commend you for continuing to read past this. Had I come across such idiocy in only the 2nd Chapter I would have tossed the book and written to the publisher suggesting it be renamed “Losses from the Peak”. Anyone who thinks a processor can profit in the face of rising input costs and falling demand should be banned from writing about investment.
The second disputed argument is that tar sands must be totally dependent upon natural gas,….
I now question whether this guy does any research or just regurgitates what he reads at the Oil Drum. As you note, upgraders can simply burn some of the input stream. The OPTI/Nexen plant at Long Lake plans to do exactly that. They claim they’ll get 60k bpd synthetic crude from 70-72 bpd of bitumen and will also export electricity. Unless they fail this will argue strongly for 5-6 oil sands EROEI and put to rest arguments about NG requirements.
I am kindly asiking, if You are aware on Finnish company named Neste Oil, which is making groundbreaking work with renewable energy.
Yes, I am well aware. In fact, I wrote about Neste in a book chapter that I recently completed on renewable diesel for a book that will be published in July: Biofuels, Solar and Wind as Renewable Energy Systems.
The Neste process (similar processes have been developed by Petrobras and ConocoPhillips) does not produce biodiesel. It produces “green diesel.” The difference is that biodiesel is the product of an esterification reaction, and contains oxygen. Green diesel is exactly the same as regular diesel, only it is produced from recently living biomass. The properties are distinct from those of biodiesel.
There is no doubt that oil and commdities have been great investments. The future may be different. Some see a refinery glut coming. I think so. Gasoline demand is only going to decline, especially in the U.S.
I think oil will be a great business for years and years — but that is different than being an investor. The peak may be now, for investors. As commodities decline in relative value, investor sentiment will shift.
There is a possibility we are in a bubble now.
doggydogworld: It might help you to realize that I wrote the book last May, when the outlook for the sour crude refiners was far different than it is today. Their margins were at a record level then, and it would have taken a remarkably prescient analyst to imagine that they would have collapsed to today’s levels.
As for just regurgitating what I read on TOD, first you should realize that I wrote some of the material there that you think I’m just regurgitating! I did a significant amount of research using many different sources, and tried to pick out what I thought was the best work; oftentimes it was work done by analysts at TOD and ASPO, but not always.
In a sector that changes as rapidly as the energy business, it’s difficult to write a static book and not wind up with at least a few things that seem out of date by the time it is published, a year later…
“(oil companies) are likely to have loads of cash for getting into other energy businesses”…but are they likely to bring any relevant skills to those businesses, or will it just be a few more cases of acquisitions gone wrong?
It is generally very difficult for a business that has been successful at one stage of a technology to succeed with a new and disruptive technology. It was Nucor, not US Steel, that pioneered the mini-mill.
In a sector that changes as rapidly as the energy business, it’s difficult to write a static book and not wind up with at least a few things that seem out of date by the time it is published, a year later
In your defense, I would also add that financial forecasting is a tough business. There are bound to be misses. If it was easy, we would all be rich.
but are they likely to bring any relevant skills to those businesses, or will it just be a few more cases of acquisitions gone wrong?
It depends. BP and Shell are both gaining a lot of experience with solar power. Others are testing the waters in biofuels. So it kind of depends on where we end up. If the future is nuclear fusion, no oil company has any expertise there, but again they have very deep pockets due to high oil prices.
Besides that, the best managers would make acquisitions and then let those with expertise run the business.
Chris: If you start at peak oil then it makes no sense to invest in refiners. Excess capacity destroys unit economics. Of course niche players can sometimes prosper even within a horrible industry. I haven’t read your book yet, if it says the refinery industry as a whole will suffer but VLO and TSO will profit due to their unique ability to process heavy/sour that’s a different story. I still think you’re wrong, but such a position is at least open to debate instead of obviously self-contradictory.
Likewise, if you only spent a paragraph on oil sands then a passing mention of natural gas limitations is forgiveable. A multi-page discussion would, on the other hand, be completely deficient if it did not mention OPTI/Nexen which has been in the news for several years.
A couple minor errors in an otherwise excellent book still makes for an excellent book. I won’t know until I read it. Meanwhile, congratulations on getting published and spend those royalty checks wisely!
Comments are closed.