Britannia Radio

	November 11, 2009

We'll Never See $50 Oil Again By Matt Badiali Analysts judge oil companies on two key statistics – reserve replacement costs and recycle ratio. In other words, how much it costs a company to replace each barrel of oil it produces and how efficiently the company does it. Analysts treat lavish exploration budgets as a black mark. So as I explained last week, many oil companies have learned to perform a little reserve shell game... You see, while oil exploration is expensive, natural gas exploration isn't. Buying up gas shale properties can add gaudy reserves at a relatively low risk and cost. That's why many public oil and gas companies added huge leases in the major shale plays over the last few years. That gas pads the companies' ratios, and that's as far as many analysts go. But this masks a critical fact: Oil reserves are falling among the giant oil companies. The three U.S. majors – Chevron, ExxonMobil, and ConocoPhillips – hold 72% of the oil reserves among the public U.S. oil companies. The oil reserves of those three fell 6% from 2005 to 2008. That 1.4 billion decline in reserves is two-thirds as much oil as the next largest oil company's entire oil reserves. A quick check of the oil industry shows only 30 companies with more than 45% oil reserves. Even venerable ExxonMobil, the best-run oil company in the world, hasn't replaced its oil reserves. In 2003, the company had 12 billion barrels of oil... Today, that's down to 10 billion barrels. That means it's replacing about 75% of its annual production. This is unsustainable in the long run. We simply aren't replacing our oil reserves, and that is important because it means oil... any oil... will be more valuable tomorrow than it is today. I don't like to make predictions about commodity prices. Usually, gut feelings are no better than a coin flip. But I can't see how we'll ever pay less than $60 a barrel for oil again. Even if oil dips below that level... it won't stay there. Finding oil is much harder today than it used to be. And it's a lot more expensive to extract. Consider Brazil's Petrobras. The company has found more than 10 billion barrels of oil at its Tupi field, off the coast of Brazil. However, that oil is buried beneath 1.3 miles of water and 3.5 miles of thick salt and sediments. It costs $240 million to drill a single well at Tupi. Tapping the field will run in the tens of billions of dollars. The story is the same all over the world. Lots of oil, but none of it cheap to extract. That's great news for Canada. The stuff in Canada's oil sands is one step above roofing tar. It is difficult to get it out of the ground, and it takes extra effort to refine. When we're rolling in easy oil and the price drops below $45 per barrel, this is a marginal business. But if oil holds above $60, as I expect it too, then the Canadian oil sands are a great investment. The big names here Suncor (SU) and Canadian Oil Sands Trust (COS on the Toronto Stock Exchange). Now, oil has more than doubled since the start of the year. I don't expect it to fall back to its lowest levels, but it could still get hit with a healthy correction. If you're buying into the oil sands now, be prepared for a few bumps in the bull market. Good investing,