Brian Gorman recently took a look at BP's big investment in alternative energy. He suggested that the driving factors behind this investment are the desire for energy independence, consumer consciousness, and government support for alternative energy. From my perspective, when I see a major oil company investing $8 billion outside the oil patch, I think of peak oil.
Over the weekend, I read Beyond Oil: The View from Hubbert's Peak by Kenneth S. Deffeyes. The book is a sequel and an update to his previous work, Hubbert's Peak: The Impending World Oil Shortage. If you can't tell from the titles, Professor Deffeyes believes that the world's production of conventional crude oil has peaked and will now decline forevermore. In fact, he predicts that Thanksgiving Day 2005 was the official "peak oil day." Put a fork in it: The age of oil is done.
Well, perhaps I exaggerate. But not too much.
I will say that the evidence is pretty compelling. He claims that the peak may have occurred in 2003 and uses Thanksgiving Day 2005 as a symbolic point in time -- a time for us to reflect upon how thankful we should be for oil's role in building our modern lives.
So, what's the point? If you believe that world oil production is about to max out like so many American credit cards, then it makes sense to look into other potential fuels for the future. Does this mean you should hop on to the next fuel-cell stock that gets hyped on TV?
I wouldn't. The great thing about investing in the future of energy is that there is little reason to gamble. Many of the companies likely to benefit from alternative-energy consumption are already profitable, sport price-to-earnings (P/E) ratios below the market average, and in some cases even pay dividends. With that in mind, let's take a look at potential alternatives for the next five years that will use the existing infrastructure, blend with existing fuels, and power existing vehicles.
Natural gas
For a while, the world thought that natural gas would be the natural replacement for crude oil. In the 1990s, most power plants were built to run on natural gas, and even a few vehicles were converted to run on it. But domestic production of natural gas is also hitting its peak, and the creation of infrastructure to import liquid natural gas (LNG) is moving along rather slowly.
The companies that hold large reserves of natural gas will likely benefit from a volatile and upward-trending price cycle, so I'd be looking at Anadarko Petroleum (NYSE:APC) and my nugget in the oil patch, Houston Exploration, just to name a couple. It may take a while, but waiting for natural gas prices to recede from current highs and buying these stocks on temporary price dips will likely make a huge difference in returns.
Coal
Coal is not a part of any environmentalist's dream, but we have a lot of it, and it works. Plus, "clean coal" is not just an industry buzz phrase. Headwaters (NYSE:HW) has invested heavily in making coal burn more cleanly. For more direct investments, you can choose between coal producers such as Arch Coal (NYSE:ACI) or Peabody Energy. If you prefer the "picks and shovels" angle, you can look at mining equipment makers Joy Global (NASDAQ:JOYG) and Bucyrus International.
The future for coal looks pretty good. Coal-fired power plants are again on the drawing boards, and even when one considers hydrogen as a fuel, it becomes evident that coal is not just for breakfast anymore.
Oil sands
I should emphasize that the peak oil argument applies only to conventional hydrocarbons that come up from the ground like a bubblin' crude. There are more oil sands than the total of all of the crude oil ever produced, and Americans will very likely be importing a ton of "syncrude" from Canada in the years to come. I highlighted just a few of the investment opportunities last month.
Ethyl alcohol (a.k.a. ethanol)
In the farm states, ethanol has been added to gasoline for a long time. Furthermore, thanks to political forces, ethanol is here to stay. There is not a senator or congressman from a farm state who would ever challenge federal mandates or subsidies for ethanol. And if gas prices increase, the call for ethanol will only grow. Here, one obvious play is Archer Daniels Midland (NYSE:ADM). Headwaters is also looking at ethanol and has entered into a joint venture to build a plant in North Dakota (link opens a PDF file).
One final note: Nothing is free. Making ethanol requires energy. With natural gas supplies pinched and nuclear power still taboo, the power is most likely to come from coal.
Hydrogen
I can hear the environmentalists cheering now. Unfortunately, hydrogen is very unlikely to become the automotive fuel of choice in the near future. There is no infrastructure, and most of the development surrounding hydrogen vehicles and fuel cells is basically in the research stage. Hydrogen as a motor fuel is more likely to occur in 50 years rather than five. Even so, the use of hydrogen is going to increase, since it is needed for refining heavier oils and oil sands. The companies to watch here are the ones that already make hydrogen: Air Products & Chemicals (NYSE:APD), BOC Group, and Air Liquide.
Oh, and by the way, hydrogen is not currently manufactured on a commercial scale from air or water. For the foreseeable future, natural gas and coal will continue to be the sources of hydrogen.
Oil shale
Like the oil sands, there is an enormous amount of oil shale. Back in the '70s, there was a boom in western Colorado as high oil prices made people think that oil shale would power the nation. Alas, it wasn't to be. However, oil shale is plentiful in the good old USA, and high oil prices do create the potential for profitable operations. For the next five years, however, I doubt that there will be anything here on a commercial scale.
Crude oil
I know, I just told you that the age of oil was over. But not quite yet. We still have at least a trillion barrels to burn. (Heaven help the folks living in low-lying areas surrounded by mountains.) The oil patch has plenty of tricks up its sleeve for increasing oil recovery from the existing wells. Applying advanced recovery technology should spell continued success for the likes of Halliburton (NYSE:HAL) and Schlumberger. Plus, the deepwater frontier is a relatively new area of exploration, and there is a chance that someone will find a supergiant field in deepwater East Africa, Brazil, or the Gulf of Mexico. With a limited supply of deepwater drilling rigs, dayrates -- the industry term for prices -- have been rising quickly for the likes of Transocean and Noble Energy.
Final thoughts
As Deffeyes points out, we won't know that we've hit the peak until after it is in the rearview mirror. After all, there is no way to prove that oil production will not be greater in some future year. A lot of respectable petroleum geologists say we are at peak oil; others, such as the folks at Cambridge Energy Research Associates, think not.
The experts do agree that the world's oil supply faces significant challenges. The largest oil fields in the North Sea and North America are in permanent production decline, and demand is rising. If oil production from somewhere else does not increase rapidly, demand will outstrip supply in the very near future. Where is that new oil going to come from? Saudi Arabia is the only OPEC member that claims to have excess capacity, but the Saudi government won't allow outsiders to independently audit the fields there.
Even if we are not sitting atop the peak, I see the supply-and-demand balance to be so tight that energy companies should lead the market for many more years. However, keep your head on your shoulders, and don't bet on everyone driving hydrogen-powered automobiles. In 20 years, the cars we drive and the fuels we fill them with will most likely be very similar to the ones we use today.
Related petro-Foolishness:
- Is Arch Coal Still a Diamond?
- It's Elementary, Peabody
- Oh, Canada's Oil Sands
- Transocean Finds Treasure Offshore
Robert Aronen owns shares of Joy Global and Transocean. Please feel free to share your comments with him at [email protected]. The Motley Fool has a disclosure policy.
