Before starting today’s essay, I have to thank Rick Rule of Global Resource Investments for his insights on the following issues.
Rick has been involved in natural resources investing since 1974. He founded Global in 1994 and has been behind many of the largest deals (Silver Standard being one) and the largest profits (between 1998 and 2006 he grew $15 into $460 million) the industry has ever seen.
I spent the better part of a recent morning discussing oil and the energy sector with him over the phone last week.
“Most people believe that most oil in the world is produced by the big oil companies, the Exxons, the Shells, the BPs, the Totals of the world,” Rick began, “That is not true. Most oil in the world is produced by national oil companies… companies owned by the state or government.”
I asked Rick what percentage of world oil production is controlled directly by governments. His answer: “at least 70%.” Rick went on to explain that this creates a situation similar to the Peak Oil theory based not on lack of resources, but lack of competence on the part of political leaders.
“Much of the cash flow generated by these state owned companies is spent on government spending programs. Now, oil and gas are capitally intensive businesses. If you do not continually reinvest, you impair your ability to produce.”
“It is my opinion that this lack of reinvested capital will create a situation in which it is inevitable that in five years the world supply of export crude from several key exporting countries will be greatly constrained of not stopped altogether. Those countries include Mexico, Venezuela, Peru, Ecuador, Indonesia and perhaps Iran.”
According to the International Energy Administration worldwide demand for crude oil imports is growing at a rate of 1.5-1.6% a year. When you combine this growth in demand with a major cut in 20-25% of world exports you have makings of what Rick calls, “a MAJOR price dislocation.”
This is something I’ve yet to hear anywhere else, especially in the mainstream media. All talk of higher oil prices that I’ve seen focuses on speculation on Wall Street (true), the view that the world is running out of oil (false), or the view that war in the Middle East will disrupt supplies (probably will be true). Nowhere is anyone talking about a cut in exports due to government misallocation of resources.
I asked Rick if his “price shock” forecast was a certain thing. He responded, “There is one potential solution which may or may not work. The Gulf States, most notably Saudi Arabia, Kuwait, and Abu Dhabi, are aggressively reinvesting in building production capacity. The issue is whether or not they can expand capacity enough to shelter the shock of the decrease in exports coming from the other countries I listed before.”
So the one group that could stop a spike in oil prices is the Middle East?
“Yes, paradoxically, the people who talk about supply issues in the US are concerned about the very nations that are our most reliable suppliers: the Persian Gulf countries. The Saudis are spectacularly reliable suppliers. They have invested tens of billions of dollars maintaining a surplus capacity of two million barrels per day specifically to level out price shocks. This suggests to me that American consumers have been massive beneficiaries of a region that they are being taught to dislike, namely the Middle East.”
Combine these insights with recent comments from a former Shell Oil executive that gas will be at $5 per gallon by 2012 and you’ve got a serious argument that energy prices will be soaring in the future.
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