Porterian

This is my personal blog. Travel, financial and political observations. Notes to myself and my friends. Content development for my monthly newsletter, Porter Stansberry's Investment Advisory (www.stansberryresearch.com).

Thursday, March 09, 2006

OIL HEADING LOWER

I was in a meeting with Matt Baldiali, our oil analyst on Monday and I had to confess to him that I think the current high price of oil is both unsustainable and something of a bubble.

Here are my reasons –

1. The oil to gold price ratio is still completely out of whack. Normally it takes about 20 barrels of oil to buy an ounce of gold. The ratio is surprisingly stable, as both oil and gold respond to world political events and inflationary pressures. But, last August the ratio fell to a record low level – 7. This can’t last: either oil has to fall, gold as to rise or both have to happen to some degree. (I should have a chart of this up by tomorrow.)

2. Wall Street believes in “peak oil” – the idea that oil prices must forever go higher because there is no more oil. The oil sector analysts are the most wildly bullish group on Wall Street: 73% of all oil service stocks are rated “buys” and 61% of oil stocks are rated “buys” – the two highest buy-rated groups. Gold is the lowest. I can tell you from experience that pro investors still think gold is a joke. I met with a dozen top private equity firms last fall, in a failed attempt to buy a large publicly traded publishing company. At each meeting I would make a point of telling the assembled “stars” that we published reports about rare gold coins. The groups laughed every single time. At some point the speculators that have bought oil as an inflation hedge will buy gold instead.

3. Individual investors have full committed to oil: assets in the Rydex Energy Services Sector Fund (RYVAX - 41.94), when adjusted for net-asset value changes, swelled by 94% during the past two months. Total assets in the fund reached a new historical high last week.

4. Norwegian billionaire John Fredriksen is at it again. He is part of a group of financiers that are building 40 new floating deep-water rigs. They cost about $600 million each, or between $15 and $20 billion altogether. I say Fredriksen is “at it again” because at the previous top in the market (1997) he raised money (Northern Offshore) to build rigs too. That company went bankrupt about a year later when oil plunged below $10 a barrel. Fredriksen’s new company, SeaDrill, raised over $800 million on claims to become the world’s fifth largest offshore drilling company. It has already committed to spend over $1 billion on new rigs.

5. A big, wildly overpriced merger. Think TimeWarner/AOL. In the oil boom, the biggest, most overpriced deal happened in December when ConocoPhillips bought Burlington Resources for $35 billion. Judged in terms of proven reserves, ConocoPhillips paid $17.50 per barrel. That’s about twice as much on a per barrel basis as Chevron paid for Unocal five months earlier.

6. Nature abhors a bubble and it won’t cooperate: too much oil is coming out of the ground. U.S. crude-oil inventories jumped 4.5 percent to 335.1 million in the four weeks ended March 3, leaving supplies at the highest since May 1999. Last week's gain was the biggest since Oct. 29, 2004, the report showed. The increase left supplies 14 percent above the five-year average.

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