Oil has fallen from about $150 per barrel all the way down to the $40-$50 range. There's nothing particularly shocking about that -- with a global recession, it's reasonable to expect the price of the most economically sensitive commodity to decline. Given that our economic outlook is as bad as it's been in 60 years, the same is happening to many other industrial commodities.
I think it's highly unlikely, however, that the selling will continue at the same rate. Developing countries still need a lot of infrastructure, and infrastructure requires resources. When this crisis is over, I expect the commodity indexes to trend back toward their all-time highs. Oil should be no exception.
It does not compute
The United States consumes 25 barrels of oil per capita, Japan consumes 16, and Korea 15. Interestingly, they all followed a very similar pattern of development. As their economies grew, oil consumption per capita expanded until it found a plateau. Developed economies ultimately become more service-oriented, so it's natural for oil consumption per capita to stop growing with GDP.
How far are China and India from stopping to grow oil consumption per capita? China consumes roughly two barrels of oil per capita. India consumes 0.9.
This would be fine and dandy if China and India did not each contain more than a billion people. But their oil consumption will grow many times in the next 20 years, assuming the global economy does not sink into a black hole. (Let's hope not!) Given this future demand, I don't think we've yet seen oil prices hit their peak. While $150 a barrel may remain the record for a while, one day it, too, could topple. The Chinese know this -- and they're taking action now.
China's move
The Chinese arranged for a $10 billion loan to Brazil's Petrobras (NYSE:PBR) in exchange for a reliable supply of oil. Petrobras needs $174.4 billion between 2009 and 2013 in order to develop oil that lies under several miles of seawater, rock, and a layer of salt. I have seen estimates that the production costs could be north of $100/barrel, although truthfully, no one really knows how much it will cost.
There's a lot of oil in hard-to-reach places in Brazil, so the Chinese must know something the experts don't. The Chinese also gave $25 billion to Rosneft, the Russian oil company that "acquired" the assets of defunct Yukos, in order to secure oil from the east.
Another high-cost alternative to deep-sea oil
Oil sands have a very high cost of development -- it varies depending on the method used -- but I've seen estimates north of $50/barrel. Canada-based Suncor (NYSE:SU) is an expert in the field.
Because Suncor is highly leveraged to the price of oil -- it takes expensive oil for the company to make money -- its shares fell from $75 in the summer of 2008 to about $15 by the end of the year. Curiously, Suncor shares have stabilized lately; they're actually up this year, despite large declines for the stock markets here and in Canada. Is the extreme oil price leverage in Suncor signaling that oil prices may have bottomed out?
The Oracle agrees
Warren Buffett wrote about the same issues in his latest letter to Berkshire Hathaway (NYSE:BRK-A) shareholders:
Last year I made a major mistake of commission. … I bought a large amount of ConocoPhillips stock when oil and gas prices were near their peak. I in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year. I still believe the odds are good that oil sells far higher in the future than the current $40-$50 price. But so far I have been dead wrong. Even if prices should rise, moreover, the terrible timing of my purchase has cost Berkshire several billion dollars.
There is a lot to like about ConocoPhillips (NYSE:COP) at current prices; it's the third-largest U.S. oil company, and in my opinion, it holds the best reserve position. The company has about 10.56 billion barrels of oil equivalent (BOE) in reserves, and production of 835 million BOE. Conoco shares are down big time, along with the price of oil -- and this is the time to begin looking.
Because of its business mix, Conoco is more leveraged to oil than Chevron (NYSE:CVX) or ExxonMobil (NYSE:XOM). It has fewer retail operations and more refining, petrochemicals, and exploration and production divisions -- meaning that there's more bang for the buck in profits as oil prices rise, and vice versa. Plus, Conoco owns 20% of Lukoil, the Russian oil company with the world's second-largest oil reserves among publicly traded companies. (No. 1 is Russia's Gazprom.)
Warren Buffett and the Chinese think that oil is likely to go higher from here. I agree. This marketwide sell-off could provide a good opportunity to think about snapping up a few shares.
More on oil and China:
