The Political Scene
...and its effects on energy supply

by Brian Graney (TMFPanic@aol.com)

ALEXANDRIA, VA (Nov. 17, 1998) -- We normally try to avoid talking about politics in this forum, but today we're going to bend our ostensible "No Politics" rule a little bit.

Don't expect a thorough expose on the latest budget crisis or scandalous details about Bill and Monica, however. Those issues are best left to the tabloids and TV commentators with bad haircuts. Instead, we will focus on how political issues affect the oil and gas industry we are studying, mostly through the lens of global oil supply.

Of course, our main objective with this study is to identify an industry-leading company that will provide us with a market-beating return over the next 20 or 30 years. That goal hasn't changed, and we should keep it in the back of our minds throughout.

So why are we focusing on international politics instead of seemingly more relevant investing topics, such as the growth potentials and financial situations of individual companies? The answer to this question, which is legitimate and warrants a good response, lies in the nature of the sector we have chosen to examine.

Choosing a good stock with market-beating potential in this industry is much like identifying the best place to plant a tree. Have you ever tried to plant a sapling in cement? Neither have I, but we can probably all agree that a sidewalk is not the optimal place to grow a magnolia tree. (This is a reality that urban planners in some metropolitan areas continue to ignore, by the way.)

In the same sense, oil and gas companies will find it much more difficult to grow their businesses in a hostile political environment. If the international political "soil" is too inhospitable, the industry's growth prospects will wilt faster than the leaves on that ill-fated urban magnolia.

Not all of the companies on The Royal Scroll have equal exposure to international political risks. Some have quite extensive domestic operations, especially in the "downstream" refining and marketing end of the business. However, as a research paper from the American Petroleum Institute pointed out earlier this year, the "upstream" exploration and production operations of the largest U.S. industry players are increasingly focusing on the overseas markets for growth.

Foreign oil's share in the annual total production numbers of the big players has risen over the last 15 years or so mostly because of a steady decline in domestic production. Meanwhile, on the natural gas side of things, the foreign share has increased due to a significant rise in overseas projects.

This trend is likely to continue over our 20- or 30-year investment horizon, since the U.S. holds a relatively small percentage of the world's estimated remaining oil reserves. According to a recent U.S. Geological Survey report, the world has an estimated 1.7 trillion barrels of oil left in the ground. However, only about 3% of those oil reserves are located in the U.S. (and another 3% are anticipated as yet undiscovered in the U.S.). So, it's clearly in the best interests of U.S. producers to look internationally for growth, because that's where most of the remaining reserves are.

Of those global reserves, about half are located within the borders of OPEC member countries, many of which operate nationalized oil companies. The remaining reserves are not as neatly organized, however, and are spread out all over the world. This is where the U.S. exploration and production companies run into political issues head-on. As much as they would probably like to, the U.S. firms cannot just set up their derricks and start drilling anywhere they want in the world.

The oil reserves themselves care very little about national borders and such nonsense, since the laws of nature still trump the laws of state, even in this modern society of "shuttle diplomacy" and pro wrestlers-turned-governors. However, governments tend to care a great deal about their boundaries and claim the natural resources that may be lying beneath their sovereign soil as their own to exploit. From what I can discern, Mexico was the first foreign country to adopt this viewpoint, way back in 1917.

To deal with the sovereignty issue, the U.S. producers arrange overseas exploration contracts or production joint ventures with foreign firms on a case-by-case basis, typically forming some sort of relationship with the governments of each country as necessary. However, sometimes things can get complicated. Many countries with oil reserves have different legal systems, business practices, and infrastructures than what U.S. firms are accustomed to dealing with back home. In fact, some countries are lacking all three of the above items. Add the U.S. government's recent affinity toward using unilateral trade agreements and sanctions as foreign trade policy tools, and tapping overseas oil and gas reserves becomes an even more difficult task for the companies on our list.

We plan to address these political issues and others in more detail down the road, most likely as we examine the international businesses of the individual oil and gas companies on our list. In the meantime, feel free to share your thoughts on this topic or any other related items on the message boards, particularly the Drip Companies board.

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11/17/98 Close

Stock Close Change CPB 55 1/2 - 7/8 INTC 108 1/2 +1 5/8 JNJ 84 7/8 - 3/8 MEL 62 7/16 + 3/4
Day Month Year History Drip 0.27% 11.16% 29.58% 10.35% S&P 500 0.30% 3.70% 17.40% 19.76% Nasdaq 0.90% 6.05% 19.62% 17.86% Last Rec'd Total # Security In At Current 09/02/98 8.027 CPB $52.867 $55.500 09/01/98 9.727 INTC $80.238 $108.500 10/07/98 7.850 JNJ $71.405 $84.875 10/07/98 1.000 MEL $48.560 $62.438 Last Rec'd Total # Security In At Value Change 09/02/98 8.027 CPB $424.36 $445.50 $21.14 09/01/98 9.727 INTC $780.50 $1055.42 $274.92 10/07/98 7.850 JNJ $560.53 $666.27 $105.74 10/07/98 1.000 MEL $48.56 $62.44 $13.88 Base: $2100.00 Cash: $237.52** Total: $2467.14

The Drip Portfolio has been divided into 89.430 shares with an average purchase price of $23.482 per share.

The portfolio began with $500 on July 28, 1997, adds $100 on the 1st of every month, and the goal is to have $150,000 in stock by August of the year 2017.

**Transactions in progress:
10/24/98: Sent $40 to buy more INTC.
10/26/98: Sending $60 to buy more JNJ.