The Oil Moat

Toyota (NYSE: TM  ) just announced its goal to sell 1 million hybrid cars per year by the beginning of the next decade, with 600,000 sold in the United States alone. Those looking for lower gas prices may think that applying hybrid technology on this scale will reduce demand and lower prices at the pump, but before buying a new V-8, gas-hungry consumers may want to think twice.

The rising cost of oil
I worked in oil refineries for nearly a decade, and there's nothing I enjoyed more than SUV owners complaining to me about gas prices. I've been out of refineries for the past three years, and now that prices have really taken off, I'm sure I've missed many more of those wonderful discussions. With Toyota's recent announcement, drivers may be wondering whether hybrid cars will stop the escalating prices. I hate to be the bearer of bad news, but my answer is no.

There are two separate factors at work: rising oil prices and limited refining capacity. First, as the headlines keep reminding us, crude oil currently sits at more than $60 a barrel, and Goldman Sachs recently projected that it will peak at more than $100 a barrel. The standard reason is that China, India, Russia, and Eastern Europe all have growing middle-class populations who will want cars and home heating and plastics, just like the rest of us. Therefore, unlike previous oil spikes, this one is driven by demand outstripping production capacity, not deliberate OPEC actions to reduce supply.

Reserves must be refined
This is not to say the world is running out of oil. In The Prize, Daniel Yergin's epic history of the oil industry, Yergin points out that projections have always said the world would run out of oil in the near future. Somehow, new discoveries have always pushed this "imminent doom" further into the future. Today, forecasts are all over the map, but with at least 1 trillion barrels of known reserves, "imminent doom" is projected somewhere between 40 years and more than 100 years in the future. It is the production capacity -- the fact that these reserves cannot be extracted fast enough to meet rising demand -- that is driving price increases. Furthermore, the reserves are deeper in the ground or under the ocean floor, and many new crude reserves are of lower-quality oil.

The second factor is refining capacity. According to the most recent petroleum inventory report, U.S. refineries are running at 95.8% capacity, which doesn't leave much room for planned maintenance or unplanned outages -- such as hurricanes shutting down plants on the Gulf Coast. No new refineries have been built in the United States in more than 20 years, and judging by the popularity refineries hold in the public imagination, I'm pretty sure there won't be any new plants added soon. Existing plants will increase capacity, but only through lengthy local permitting processes. As demand keeps rising, I'd expect refiners to continue operation above 90% capacity well into the future.

The hybrid effect
With 600,000 hybrid vehicles on U.S. roads, the demand for refined product will be reduced, right? Unfortunately, with American gasoline demand up to 9.5 million barrels per day, 600,000 hybrids will reduce demand by less than 0.1% (my estimate). It will take tens of millions of hybrid vehicles before there is a sizable impact on American gasoline consumption. It is great to see new technology and a new interest in fuel efficiency in the American marketplace, but in the short term, it doesn't look like it will be enough to put a dent in demand.

Foolish final thoughts
Great long-term investments benefit from a moat that keeps revenues high and growing, and moats are one characteristic the team at Motley Fool Hidden Gems uses to identify superior stocks for subscribers. If you agree that we'll be living in a world with sustained high crude oil and gasoline prices, then oil presents just that kind of moat.

Hidden Gems analyst Bill Mann recommended refiner Valero (NYSE: VLO  ) back in June 2003 -- before record prices were front-page news. The stock is up almost 400% since that time and is now the best-performing stock in the S&P 500 index. And with no new refineries on the horizon, Valero could still go higher.

Going forward, there may also be opportunities in CarboCeramics (NYSE: CRR  ) , which helps companies extract oil from deeper and deeper wells, or SuncorEnergy (NYSE: SU  ) , which has attracted a ton of attention with its huge stock of Canadian oil sands -- where reserve volumes are nearly as large as the reserves in Saudi Arabia. High crude prices also offer a wealth of choices in exploration companies, including foreign players such as PetroKazakhstan (NYSE: PKZ  ) . The more conservative investors among us can cover just about all bases with an integrated giant such as ExxonMobil (NYSE: XOM  ) .

On a personal level, though, you might consider saving a few dollars at the pump with one of those new hybrids.

Want two thoroughly researched stock picks per month? Fool co-founder Tom Gardner is offering a free 30-day trial to Hidden Gems, the Fool's small-cap stock newsletter.Since inception, Hidden Gems recommendations are up more than 30% on average, vs. 10.42% for the S&P 500. Click here to learn more.

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Robert Aronen does not own shares in any company mentioned in this article. The Motley Fool has a full disclosure policy.


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