In response to yesterday's article on why I oppose offshore drilling, Jonathan sent the following:
Let me tell you a little tale.
I went to grades 6-12 in a small Washington state lumber town. It was a company town whose sole economy consisted of the lumber mill and the logging operations that supported it. The mill cut primarily old growth timber. During four summers of college, I worked in that mill doing enchanting things like cleaning out the pit, pulling on the chain and jackhammering the boilers.
One day, along came concern about a small, endangered bird called the Spotted Owl. Political talk arose about preventing logging in the small remnant of old growth timber, as this was the bird's primary habitat.
You can imagine what the townspeople said: "Goddamn owls! This is our livelihood! Cut the f@*&$ timber!" Even so, the mill hands knew the old growth was about gone. I know they knew it because I heard them talk about it in the break-shack. My father, an executive, knew it too. In fact, anyone who wasn't an idiot knew it.
(Although I admit that's setting the bar unfairly high in that town's case. To preempt the reader's first logical question, it's not that there wasn't enough replanted timber. The problem there was that the elderly mills were all set up to cut big logs, and would essentially require complete retooling in order to cut smaller new-growth logs economically. The companies didn't want to completely rebuild their mills.)
It was therefore certain that this town's primary economy would die out. The town had a couple of options. It could either keep yammering for a few more years of old growth cutting -- after which the cry of TIMBER! would be silenced anyway, leaving them in the same mess -- or it could begin to reinvent itself around its spectacular scenery, ultra-cheap housing, safe rural school, superb fishing, and excellent hunting. (Naturally, it took about fifteen years to decide on the latter.)
Thus it is with petroleum.
Those bellowing to drill-drill-drill now-now-now remind me very much of the townspeople who voluntarily chose not to see that their way of life would change, and that the sooner they changed it on their own terms the less the world would dictate that change to them.
The world has a firearm pointed at the United States, and that firearm is oil. As long as we depend upon petroleum, we will be enmeshed in affairs that would otherwise be "not our problem." Petroleum revenue has, in the main, been used against us and our interests by its recipients.
The day we cease to depend on petroleum is the day those bloated economies begin to recede to something approximating what they would have been without petroleum. But like the timber back in my little town, its days are numbered. We either take Erlenmeyer flasks and pipettes in hand and use our scientific know-how to find reasonable alternatives to petroleum, or we continue to let the likes of Hugo Chavez and the Wahhabis have far too much say in our future. OPEC was founded to counter the Seven Sisters cartel, and it did its job well.
My Aug. 5 article about offshore drilling elicited thoughtful replies from readers, as is usual around here. This site doesn't attract much of the ruck crushed around popular message boards, for which I'm grateful.
Rob found in Newt Gingrich's Winning The Futurenewsletter "a study by two economists that argues that drilling in ANWR would produce an immediate drop in oil prices even if the oil did not enter refineries for several years. Interestingly, this study was rejected for publication in The Energy Journal, not because they disagreed with the findings, but because they considered the study's conclusion so obvious that it was not worth publishing!"
Ric sent along the results of the first U.S. Geological Survey (USGS) resource estimate for the area in Alaska north of the Arctic Circle. From Congressman John Culberson's (R-TX) website in reference to the study:
According the USGS, the area north of the Arctic Circle has an estimated 90 billion barrels of undiscovered, technically recoverable oil, 1,670 trillion cubic feet of technically recoverable natural gas, and 44 billion barrels of technically recoverable natural gas liquids in 25 geologically defined areas thought to have potential for petroleum.
These resources account for about 22 percent of the undiscovered, technically recoverable resources in the world. The Arctic accounts for about 13 percent of the undiscovered oil, 30 percent of the undiscovered natural gas, and 20 percent of the undiscovered natural gas liquids in the world. About 84 percent of the estimated resources are expected to occur offshore.
We know the resources are there and we know we have technology available today to recover the oil in an environmentally-responsible manner. Congress needs to act now to bring relief to American families. If our country is ever to be energy self-sufficient, we must be able to access our own energy resources.
Meanwhile, the Natural Resources Defense Council Action Fund has countered such sentiment with an ad campaign decrying offshore drilling for oil. It tells visitors to its website that they should tell Congress they won't buy the lie: "The Bush Administration wants Americans to believe that drilling in the Arctic Refuge and off our coastlines will ease our pain at the gas pump. In reality, it would lower gas prices by mere pennies -- and that would be 20 years from now!"
Here's the pre-written letter that the NRDC Action Fund suggests sending to congresspeople and senators:
I am not buying the lie, promoted by President Bush, that sacrificing the Arctic National Wildlife Refuge and America's coastal waters to oil drilling would make a real difference in gas prices -- either today or twenty years from today! I oppose any legislation that would remove the ban on oil development in these treasured places.
With just three percent of the world's oil reserves, our nation simply doesn't have enough oil to impact the global market or drill our way to lower prices at the pump. Putting rigs in the Arctic Refuge and off our spectacular coastlines would certainly boost oil company profits, but it would impoverish our natural heritage and deepen our already destructive dependence on oil.
We deserve real solutions to high energy prices -- not gimmicks and land grabs. Please support legislation that will help our nation kick the oil habit and usher in a cleaner, greener energy future. I urge you to promote measures that will make our vehicles far more fuel efficient, put millions of plug-in hybrids on the road and connect them to a cleaner electric grid, dramatically boost our reliance on renewables like wind and solar, and limit America's global warming pollution in order to spur innovation in energy technologies.
President Bush's "Drill It All" policies and his rejection of cleaner alternatives have gotten us into this mess. They will not get us out. Please take bold action that will move America beyond oil and into a more sustainable energy future.
The fund's "Elixir" ad ran in The Washington Post. You can see it exactly as it ran here. Below is the main text:
With our economy sinking and oil prices soaring, George Bush is offering snake oil: a plan to sacrifice more of our coasts to oil drilling on the chance it will produce a few weeks' worth of oil and reduce gas prices by a few pennies a gallon...in 2028. Imagine America forever tethered to Bush's failed energy policy. It's like giving him five more terms.
It's a cruel Shell game. And BP game. And ExxonMobil game. Over the past five years, the number of domestic drilling permits has nearly doubled. But because of rising worldwide demand, oil prices have skyrocketed. More drilling off our coasts is not the answer. Once destroyed they can never be replaced. The only winners will be the oil companies.
Want gas at $1 a gallon? America needs a bold new approach to energy, from more fuel efficient vehicles to plug-in hybrids and electric cars. A cleaner electric grid powered by renewables. Existing technologies could have us driving at the equivalent of a buck a gallon for gas!
Tell your Representative and Senators to stop the giveaway of our coasts. Tell them you won't stand for billions more for oil companies -- and snake oil for the rest of us.
The Washington Post itself responded to the NRDC Action Fund ad in a nice editorial yesterday. It said that environmentalists made some excellent points in the debate over whether the U.S. should drill off its shores. It agreed that "the Arctic National Wildlife Refuge, with its varied and sensitive ecosystems, should be preserved. . . . That pristine area must remain off-limits."
However, it challenged "three 'truths' masquerading as fact among drilling opponents" in a quick list:
Drilling is pointless because the United States has only 3 percent of the world's oil reserves. This refers only to known oil reserves, and most of our estimates are old and were made with outdated equipment. "In short, there could be much more oil under the sea than previously known."
The oil companies aren't using the leases they already have. This one is just a myth. Oil companies have spent hundreds of millions of dollars exploring and constructing infrastructure to bring oil to market. Just because a lease is not yet producing the 130,000 barrels of oil a day to be deemed "active" doesn't mean it's being sat upon. "With oil prices still above $100 a barrel, that charge never made sense."
Drilling is environmentally dangerous. Safety measures are pretty good these days. According to the Interior Department's Minerals Management Service, "between 1993 and 2007, there were 651 spills of all sizes at OCS facilities (in federal waters three miles or more offshore) that released 47,800 barrels of oil. With 7.5 billion barrels of oil produced in that time, that equates to 1 barrel of oil spilled per 156,900 barrels produced. That's not to minimize the danger. But no form of energy is perfect or without trade-offs. Besides, if it is acceptable to drill in the Caspian Sea and in developing countries such as Nigeria where environmental concerns are equally important, it's hard to explain why the United States should rule out drilling off its own coasts."
The editorial concludes:
No, the United States cannot drill its way to energy independence. But with the roaring economies of China and India gobbling up oil in the two countries' latter-day industrial revolutions, the United States can no longer afford to turn its back on finding all the sources of fuel necessary to maintain its economy and its standard of living. What's required is a long-term, comprehensive plan that includes wind, solar, geothermal, biofuels and nuclear -- and that acknowledges that oil and gas will be instrumental to the U.S. economy for many years to come.
In politics, we hear the word "change" bandied about and cheered for frequently. People love change, it seems, but when it comes to the actual moment of change, they shrink back.
I would say that it is not acceptable to drill in the Caspian Sea and off developing countries such as Nigeria. The environmental damage caused by oil is well documented, not just from the getting it but also from the using it. Any child who's ridden in a car behind a smoke-spewing truck can testify to the polluting characteristics of internal combustion engines.
The very reason we have a gasoline price crisis and an environmental crisis is that the world is dependent on oil. How can the right answer to the problem be a way to extend the dependence?
It doesn't really matter how much oil is available under ANWR or other places within U.S. borders because:
if it's too little, it's not worth it, and,
if it's a lot, we'll just extend the deleterious carbon age that much longer.
Everybody agrees that massive changes are necessary, but almost nobody is willing to take the massive steps. If government was bold enough to say simply "no more oil supplies" it would force the market to change to a new energy source ASAP. This is a part of free markets that is known to not work well. Regulation is needed because of a generational gap that enables companies to keep promoting harmful products well past the lifespan of those who protest them along the way.
Think about it. Can you even remember the environmental protests that occurred in 1969 when 80,000 barrels of oil from an offshore well washed up on the beaches of Santa Barbara? Probably not. People born now see that they have no choices when it comes to getting in a car for transportation because the choices were made decades ago -- and the system is locked down. Ripping it up from the bolts will not be a smooth process. It's necessary, though. If left to their own, oil companies will keep selling oil to the last barrel even as the world dies while superior technologies wait on the sidelines, ready to go.
Our collective foot has to be put down at some point.
We can't say we want change, say that oil is bad, lament the loss of wildlife and fresh air, moan about high gas prices, and then choose more of the same as the solution.
No more of the same, is the solution. Enough is enough, is the solution. We've tried your way for too many decades already and we want to move on, is the solution.
Al Gore's speech about getting beyond oil within ten years was a lot better than the excerpts propped up and attacked in the media. Here are some highlights:
We're borrowing money from China to buy oil from the Persian Gulf to burn it in ways that destroy the planet. Every bit of that's got to change.
The answer is to end our reliance on carbon-based fuels.
What if we could use fuels that are not expensive, don't cause pollution and are abundantly available right here at home?
We have such fuels. Scientists have confirmed that enough solar energy falls on the surface of the earth every 40 minutes to meet 100 percent of the entire world's energy needs for a full year. Tapping just a small portion of this solar energy could provide all of the electricity America uses.
And enough wind power blows through the Midwest corridor every day to also meet 100 percent of US electricity demand. Geothermal energy, similarly, is capable of providing enormous supplies of electricity for America.
The quickest, cheapest and best way to start using all this renewable energy is in the production of electricity. In fact, we can start right now using solar power, wind power and geothermal power to make electricity for our homes and businesses.
But to make this exciting potential a reality, and truly solve our nation's problems, we need a new start.
That's why I'm proposing today a strategic initiative designed to free us from the crises that are holding us down and to regain control of our own destiny. It's not the only thing we need to do. But this strategic challenge is the lynchpin of a bold new strategy needed to re-power America.
Today I challenge our nation to commit to producing 100 percent of our electricity from renewable energy and truly clean carbon-free sources within 10 years.
A few years ago, it would not have been possible to issue such a challenge. But here's what's changed: the sharp cost reductions now beginning to take place in solar, wind, and geothermal power - coupled with the recent dramatic price increases for oil and coal - have radically changed the economics of energy.
When I first went to Congress 32 years ago, I listened to experts testify that if oil ever got to $35 a barrel, then renewable sources of energy would become competitive. Well, today, the price of oil is over $135 per barrel. And sure enough, billions of dollars of new investment are flowing into the development of concentrated solar thermal, photovoltaics, windmills, geothermal plants, and a variety of ingenious new ways to improve our efficiency and conserve presently wasted energy.
And as the demand for renewable energy grows, the costs will continue to fall. Let me give you one revealing example: the price of the specialized silicon used to make solar cells was recently as high as $300 per kilogram. But the newest contracts have prices as low as $50 a kilogram.
You know, the same thing happened with computer chips - also made out of silicon. The price paid for the same performance came down by 50 percent every 18 months - year after year, and that's what's happened for 40 years in a row.
To those who say the costs are still too high: I ask them to consider whether the costs of oil and coal will ever stop increasing if we keep relying on quickly depleting energy sources to feed a rapidly growing demand all around the world. When demand for oil and coal increases, their price goes up. When demand for solar cells increases, the price often comes down.
When we send money to foreign countries to buy nearly 70 percent of the oil we use every day, they build new skyscrapers and we lose jobs. When we spend that money building solar arrays and windmills, we build competitive industries and gain jobs here at home.
To those who say 10 years is not enough time, I respectfully ask them to consider what the world's scientists are telling us about the risks we face if we don't act in 10 years. The leading experts predict that we have less than 10 years to make dramatic changes in our global warming pollution lest we lose our ability to ever recover from this environmental crisis. When the use of oil and coal goes up, pollution goes up. When the use of solar, wind and geothermal increases, pollution comes down.
When President John F. Kennedy challenged our nation to land a man on the moon and bring him back safely in 10 years, many people doubted we could accomplish that goal. But 8 years and 2 months later, Neil Armstrong and Buzz Aldrin walked on the surface of the moon.
Of course the greatest obstacle to meeting the challenge of 100 percent renewable electricity in 10 years may be the deep dysfunction of our politics and our self-governing system as it exists today. In recent years, our politics has tended toward incremental proposals made up of small policies designed to avoid offending special interests, alternating with occasional baby steps in the right direction. Our democracy has become sclerotic at a time when these crises require boldness.
It is only a truly dysfunctional system that would buy into the perverse logic that the short-term answer to high gasoline prices is drilling for more oil ten years from now.
Am I the only one who finds it strange that our government so often adopts a so-called solution that has absolutely nothing to do with the problem it is supposed to address? When people rightly complain about higher gasoline prices, we propose to give more money to the oil companies and pretend that they're going to bring gasoline prices down. It will do nothing of the sort, and everyone knows it. If we keep going back to the same policies that have never ever worked in the past and have served only to produce the highest gasoline prices in history alongside the greatest oil company profits in history, nobody should be surprised if we get the same result over and over again. But the Congress may be poised to move in that direction anyway because some of them are being stampeded by lobbyists for special interests that know how to make the system work for them instead of the American people.
If you want to know the truth about gasoline prices, here it is: the exploding demand for oil, especially in places like China, is overwhelming the rate of new discoveries by so much that oil prices are almost certain to continue upward over time no matter what the oil companies promise. And politicians cannot bring gasoline prices down in the short term.
However, there actually is one extremely effective way to bring the costs of driving a car way down within a few short years. The way to bring gas prices down is to end our dependence on oil and use the renewable sources that can give us the equivalent of $1 per gallon gasoline.
Our entire civilization depends upon us now embarking on a new journey of exploration and discovery. Our success depends on our willingness as a people to undertake this journey and to complete it within 10 years. Once again, we have an opportunity to take a giant leap for humankind.
I enjoy your wry looks at politics. What's the nuttiest thing you've heard in the presidential campaign so far?
That the solution to high oil prices is offshore drilling. This is inane in several ways:
The reason we're damaged by high oil prices is that we're dependent on oil. We need to get rid of that dependence, not find a way to extend it.
As if you needed it, the ability of this solution to find any support among citizens provides more evidence that the preponderance of people are woefully ignorant. Offshore drilling will have no measurable impact on gasoline prices for at least 10 years. Even then, the amount of oil added to the nation's intake would be so small that the price per gallon would drop somewhere on the order of 5 cents.
For such a small -- come on, meaningless -- benefit, we're going to further damage the already reeling environment?
The only lesson anybody should take from high oil prices is that it's high time we move beyond the carbon age. We've had the capability to drive nothing but all-electric vehicles (not halfway hybrids) for the past fifty years. What do you think vehicles inside warehouses run on? The only reason you're pumping expensive, dirty, terrorist-funding gasoline into your car is that oil companies want you to do so and have paid all the right people to be sure you must. Understand that. Exxon Mobil earned $11.7 billion in profits last quarter alone, a 14% increase and the largest single quarter profit in U.S. history.
I don't endorse Democrats or Republicans on this site. Whenever I've reported facts in the past eight years, however, I've been accused of being a Democrat because recent facts show Democratic positions to be the most sensible. Back in the 1980s, the opposite was true.
With that caveat duly noted, let's look at what each of our current presidential candidates says about our energy situation.
Here's John McCain:
We need to off-shore drill for oil and natural gas, and anybody who says we can achieve energy independence without using and increasing these existing energy resources either doesn't have the experience to understand the challenge we face or isn't giving the American people some straight talk. -- ABC News
The current federal moratorium on drilling in the Outer Continental Shelf stands in the way of energy exploration and production. John McCain believes it is time for the federal government to lift these restrictions and to put our own reserves to use. There is no easier or more direct way to prove to the world that we will no longer be subject to the whims of others than to expand our production capabilities. -- John McCain for President website
Here's Barack Obama:
You won't hear me say this too often, but I couldn't agree more with the explanation that Senator McCain offered a few weeks ago. He said, "Our dangerous dependence on foreign oil has been thirty years in the making, and was caused by the failure of politicians in Washington to think long-term about the future of the country."
What Senator McCain neglected to mention was that during those thirty years, he was in Washington for twenty-six of them. And in all that time, he did little to reduce our dependence on foreign oil. He voted against increased fuel efficiency standards and opposed legislation that included tax credits for more efficient cars. He voted against renewable sources of energy. Against clean biofuels. Against solar power. Against wind power. Against an energy bill that -- while far from perfect -- represented the largest investment in renewable sources of energy in the history of this country. So when Senator McCain talks about the failure of politicians in Washington to do anything about our energy crisis, it's important to remember that he's been a part of that failure. Now, after years of inaction, and in the face of public frustration over rising gas prices, the only energy proposal he's really promoting is more offshore drilling -- a position he recently adopted that has become the centerpiece of his plan, and one that will not make a real dent in current gas prices or meet the long-term challenge of energy independence.
George Bush's own Energy Department has said that if we opened up new areas to drilling today, we wouldn't see a single drop of oil for seven years. Seven years. And Senator McCain knows that, which is why he admitted that his plan would only provide "psychological" relief to consumers. He also knows that if we opened up and drilled on every single square inch of our land and our shores, we would still find only three percent of the world's oil reserves. Three percent for a country that uses 25% of the world's oil. Even Texas oilman Boone Pickens, who's calling for major new investments in alternative energy, has said, "this is one emergency we can't drill our way out of." -- Lansing, Michigan speech
If you would like to email me to express your opinion on this subject, please provide supporting evidence. I'm interested in discussions, not rants.
It is my thought that if the Democratic party takes office, it may be of some value to hold alternative energy stocks, both in the short and long terms. There could be a short-term spike due to a renewed government investment in R&D in these areas.
A Democratic administration would not necessarily be better than a Republican for alternative energy stocks. I'm currently researching them for The Kelly Letter's portfolio, where we already own one company making a big splash in the solar industry.
What I've found is that the price of oil and the performance of alternative energy stocks is closely correlated. When oil's expensive, the allure of other forms of energy goes up. Their prospects look brighter so, therefore, the prices of companies working on them rise on the increased interest in the sector.
The price of oil is a short-term factor. No president has much control over it, regardless of party affiliation. Also, when oil prices are rising and green energy investments are rising with it, oil investments still tend to be the better performing of the two sectors.
For instance, the proxy I use for green energy investments in the letter is PowerShares WilderHill Clean Energy (PBW).
PBW is up 19% so far this year. That's good, except that PowerShares Dynamic Oil & Gas Services (PXJ) is up 29%. If you're good at stock analysis and believe you can beat a general grouping of stocks in the sector, as we do here at The Kelly Letter, then you might have chosen the oilfield services company we bought, which is up 37% year-to-date and 56% since we invested.
That skill wasn't necessary to do better than the alternative energy companies, though. Index vs. index, oil came out better than green energies in an environment of rising oil prices.
First, ignore who's president when deciding where to invest your energy dollars. Pay attention to the price of oil. The Kelly Letter's projection for oil prices is for strength in the near term, weakness in the medium term, and strength again in the long term.
Second, understand that the short-term performance of alternative energy stocks looks to be as dependent on the price of oil as oil stocks themselves.
Third, when alternative energy stocks do well, oil stocks tend to do even better.
Now, some will see this as the entirely wrong approach. Shouldn't we invest where we hope to see the world heading, not in an energy source that's destroying the planet?
Let me share a dirty little secret with you. We could already be living without gasoline. Talk long and seriously with anybody deep inside the oil business and you know what they'll mention? That electric cars have been possible for the past 100 years, and that the only reason we're still puffing around in oil-burning models is that powerful entities want to sell every last drop of oil -- and you can be sure they'll find that last drop.
Ever been inside a warehouse? Look at the vehicles there. Forklifts and other machinery are all electric, as they have been for decades. Some of the machines can go days or a week with no re-charge. Anybody who's ever operated one has wondered, couldn't this just take me home tonight? Ten years ago, it did take some people home. One day, such a car might do so again, and in style.
If you live long enough, watch what happens when the last barrel of crude is pumped, shipped, and refined. The next day, miraculously, there will be another form of energy available and, lo and behold, the cars that can use it are built and ready to go. Amazing timing!
What's more, guess who's going to be selling that new form of energy? It won't be GreenFuel Technologies, much as we all admire their algae aspirations. It will be a familiar roster of names: BP, ChevronTexaco, ExxonMobil, Shell, and the gang.
You didn't really think such established corporations were oblivious to the end of the oil age, did you? Each one of those companies has entire departments dedicated to future scenario building, and they're phenomenally good at it. They have contingencies for nuclear wars wiping out oil fields, political coups shutting down shipping lanes, meteor impacts, and most assuredly the end of a finite supply of oil. That last one is the easiest to foresee.
They are the ones spending the most amount of money on alternative energy sources, and they will buy any small company that creates the holy grail before they do. They are not oil companies, per se, they're energy companies. Oil just happens to be the world's current source of energy.
In the end, the very best way to make money off alternative energy might be through buying the firms that environmentalists see as the enemy: traditional oil and gas companies.
In any event, the end of oil is a long ways off and the likelihood of a viable alternative appearing in the short term is remote. Corn ethanol? Forget it. It takes 1 unit of fossil-fuel energy input to get 1.3 units of corn ethanol output. Prairie grass cellulosic ethanol has a 1:2 ratio, and biodiesel a 1:2.5 ratio. Cane ethanol is better at a ratio of 1:8, but it, too, has drawbacks.
"If alcohol is now considered a 'clean' fuel, the process of making it is very dirty," Sao Paulo Public Ministry prosecutor Marcelo Pedroso Goulart told National Geographic. "Especially the burning of cane and the exploitation of the cane workers." This from the country of Brazil where 85% of cars are flex models that can burn gasoline or alcohol. Recently, with alcohol running cheaper than gasoline, almost nobody in Brazil is running on gas.
Yet, it remains a petroleum economy. Magic bullets are hard to find. We're all rooting for the algae pump to end our dependence on oil, but that's not where to put your money yet.
Energy is not a fickle industry. It's one of the best developed and best managed on the planet. It's not going away. Your money invested in energy is safe. Do not sell because of currently low oil prices. They will eventually rise again.
If anything, watch the oil sector with an eye on buying.
That was a good call so far.
Oil closed this week at $59.89, near the highest it's been all year and 15.2% higher than its $51.99 close on Jan. 19, the Friday before I posted the oil report. That's quite a rebound in just three weeks.
Exxon Mobile reported 2006 profits last week, and they were the highest that any company in U.S. history has ever reported. That's a pretty good indication of the kind of business that oil provides.
Oil stocks have done well. I suggested in the report that both Baker Hughes (BHI), BJ Services (BJS), and Grant Prideco (GRP) looked like good buys. In the past three weeks, here's how the three have done:
BHI: +6% BJS: +3% GRP: +13%
Three weeks does not a successful investment make around here, but it's a good start to what I think will be successful long-term holdings.
To those of you who were worried about your oil portfolio three weeks ago, I urge you to remember this mini-experience. Investments bought for sound reasons at reasonable prices need not be sold under duress at market lows. If anything, down markets are a swell time to buy more. This is why I am so meticulous in researching and patient to buy. Doing so gives peace of mind when the market moves against you. Trading junk requires extremely good timing, which few people have, because junk doesn't afford the luxury of relaxing when prices move lower.
Oil companies like the ones I mentioned in the report are not junk. They're excellent businesses.
Congratulations if you held or bought more. You must feel better these days than you did just a few weeks ago.
The price of oil is down 16% this year. West Texas Intermediate spot prices closed the week $1 lower than last at $51.99 per barrel.
I received a lot of email from subscribers who invested heavily in oil-related stocks. They're wondering if they blew it and should sell now to limit losses.
No.
One way to find comfort is by comparing the behavior of oil stocks with the price of the commodity itself. The Energy Select Sector SPDR (XLE) has the following top five holdings:
So far this year, while oil itself has dropped 16%, the Energy Select SPDR is down just 3.5%. That strong resilience is a positive sign, and probably means that crude doesn't have much farther to fall.
Grant Prideco (GRP), the only oil stock owned by The Kelly Letter, is down 7% so far this year. That's a reasonable slide against oil's greater losses. Overall, we're up 6% in Grant.
Now, think about who uses a lot of oil. Transportation stocks. There's a handy way to see how they're doing: monitor the Dow Jones Transportation Average, which consists of twenty stocks such as AMR Corp. (AMR), Continental Airlines (CAL), FedEx (FDX), J.B. Hunt (JBHT), JetBlue (JBLU), Ryder (R), Southwest Airlines (LUV), Union Pacific (UNP), and United Parcel Service (UPS).
If oil is truly down for the count, the Dow Transports should be on a steady run higher because their costs are coming down. Transportation investors are a smart bunch, and one of the factors they watch more closely than most people is the price of fuel, which is determined in part by the price of oil.
So, what are the transports doing? Not much. They're up 7% to right about where they were in mid-November, testament that oil has been declining but not enough of a tear to imply a longer-term trend.
Lest memory fail you, think back to 2003 when the U.S. first invaded Iraq and there was a not-surprising victory over the Iraqi army followed by President Bush's "Mission Accomplished" speech.
According to the Energy Information Administration, the spot price of Cushing, OK WTI dropped 22% from $35.83 in February to $28.11 in May. It averaged $30.66 in April, $30.75 in July, $31.57 in August, and touched its second bottom at $28.31 in September. From there, it embarked on its tremendous bull run to $74 last July. Even after the good news of a supposedly quick resolution to the Iraq war in 2003, oil wasted little time adjusting itself upward.
Ask yourself, "Have the geopolitical risks increased or decreased in the Middle East?" You know that higher risks in the Middle East contribute to higher oil prices. If we see rising risk in that region, it's safe to bet on higher oil.
The U.S. just committed even more troops to Iraq. The war is widening, not wrapping up. Iran is looking more hostile toward the U.S., not friendlier. China and Russia are cooperating to lock up more of the world's oil, not less. Those factors point to higher oil, not lower.
Banc of America investment strategist Joe Quinlan thinks that investors have "reached the point of maximum complacency" regarding the Middle East and oil prices.
Then, there are the alternative energy types who say that fossil fuels are on their way out. That's a beautiful picture of the world and one I'd like to see in my lifetime, but it ain't where the smart money sits.
According to the EIA's "Annual Energy Outlook 2007 with Projections to 2030 (Early Release)," oil, coal, and natural gas will constitute the same 86% share of the total U.S. primary energy supply in 2030 that they did in 2005. From the report:
The expected rapid growth in the use of biofuels and other nonhydropower renewable energy sources begins from a very low current share of total energy use; hydroelectric power production, which accounts for the bulk of current renewable electricity supply, is nearly stagnant; and the share of total electricity supplied from nuclear power falls despite the projected new plant builds, which more than offset retirements, because the overall market for electricity continues to expand rapidly in the projection.
You can be sure that if the outlook in the enlightened U.S. is all about fossil fuels, it's even more so in developing regions of the world.
Which brings us to an unavoidable fact. The oil story is simply this: demand is rising, supply is falling. That leads to higher prices over time.
T. Boone Pickens, one of the leading figures in the oil business, is calling for an average oil price of $70 per barrel this year.
Oil prices will rise. They might not next week, perhaps not even next month. However, the intermediate- and long-term trend is unmistakable.
Rather than selling out of fossil energy positions in this momentary downward blip, I suggest looking for places to buy in preparation for higher prices down the road.
Two that come to mind are Baker Hughes (BHI $67) for oil and BJ Services (BJS $26) for natural gas. Since last July, they're down about 20% and 24% respectively.
Natural gas is not the focus of this report, but stocks involved in it often move in sympathy with oil stocks because weather patterns affect both. For instance, we're seeing lower oil and natural gas prices now partly because of a warm winter. They rose on Friday, and the most commonly cited reason was that next week will be cold in Chicago and New York.
As is my way, I'd keep watching a while longer. Oil could get all the way down to $45 before real panic conditions begin peeking out. A downside risk is that energy companies will issue profit warnings and blame lower oil prices. That would send prices a leg lower and be a perfect time for bargain hunting.
Energy is not a fickle industry. It's one of the best developed and best managed on the planet. It's not going away. Your money invested in energy is safe. Do not sell because of currently low oil prices. They will eventually rise again.
If anything, watch the oil sector with an eye on buying.
