Peak Oil and Investing

July 15, 2007 7:06 PM

Investing to benefit from Peak Oil while entering retirement.

I am substantially convinced of the following:
1) We are, and will be, dealing with Peak Oil because of resource depletion and increased global demand—whether Peal Oil is now or in twenty years is somewhat irrelevant for this question
2) Petroleum based products will become more and more expensive
3) Nuclear, renewable and other alternative energy sources will be developed but will not significantly solve the oil problem for 20-50 years. Conservation will also help a bit but not off set increased global demand.
4) There will continue to be substantial political, if not military, instability in the Mid East, Russia will continue shepherding its petroleum resources and more global oil reserves will come under state control.
5) Supply will not meet demand and US and global industrial needs and infrastructure will continue to push oil in to the $100.00 bbl. plus ( and upward) within the next few years.

Assuming the above is true (these are not the questions) do you have any investment advice for me. I am 65, retired and can live reasonably/modestly on Social Security plus interest income based on 7% earning on principal. I have a fairly conservative portfolio with roughly 25% in fixed income, substantial international diversification, investment in US based international companies, several global and US indexes and a smattering of foreign denominated investments. I am generally comfortable with my portfolio but I am wondering how to best position myself to benefit (and not lose principal) based on Peak Oil. Once again, I am not asking to debate peak oil but rather look at it as an investment opportunity for one my age.

posted by rmhsinc to work & money (31 comments total)

Assuming the above is true (these are not the questions) do you have any investment advice for me.

Stay away from commodities. Some very smart people lost a few billion dollars on a similar kind of bet last year, except they were expecting more hurricanes.

It sounds like you have a very nicely diversified portfolio as it is. If you can stand a 5% loss annually, consider taking 5% of your portfolio and using it to speculate in whatever you think will benefit primarily from your peak oil scenario.
posted by b1tr0t at 7:14 PM on July 15, 2007

If you think oil prices are heading materially higher (relative to the market "consensus"), you may want to invest in petroleum names like:
Resources and reserves in the ground (like Conoco or Exxon, etc)
Offshore drillers (Transocean, Diamond Offshore, etc)
Exploration equipment (Vallourec, Weatherford, etc)

Or you can try to profit from some alternative energy stocks, like Vestas (wind) or MEMC (solar).

Or you can take a bet on Uranium going higher in something like Cameco. I don't know a good way to play nuclear without owning Uranium reserves. Maybe someone else does.

Many/most of those names are expensive stocks, and may well get crushed in a recession, as a DCF built for $100 oil looks like shit at $50. Remember, when you buy stocks like these, you're probably buying them from someone who understands the fundamentals better than you do.

I am not a financial advisor, and I most certainly not your financial advisor. This is not financial advice. You ought to see a qualified professional.
posted by Kwantsar at 7:38 PM on July 15, 2007

I would recommend sticking to your diversified portfolio because trying to guess the implications of peak oil in isolation from all the other future imponderables like economic cycles, technology change, wars, political change, social change, demographics, etc is a lost cause. If we can't predict the future, the best strategy is to remain diversified and spend conservatively.

With regard to the last item, most financial planners would consider a 7% withdrawal rate from a portfolio to be overly optimistic. If you are healthy, you could expect to live another 25 to 30 years in which inflation with eat away at your income. You could end up broke before you die. The general recommendation is to start with a 5% withdrawal from your portfolio at the time of retirement and increase that dollar amount by the rate of inflation each year. You might be interested in looking at a summary of the Trinity study.
posted by JackFlash at 7:39 PM on July 15, 2007

I agree with the advice given above that a relatively conservative diversified portfolio is the best bet for you.

That said, my advice given your assumptions is that you consider oil companies with reasonable valuations that are not located in the Middle East or Russia. Specifically, Brazilian oil companies such as Petroleo Brasileiro (PBR), and Canadian oil companies like Suncor (SU) and Encana (ECA). All have P/Es under 17. They are likely to profit from increased demand for oil, while being large and stable enough to preserve your principal about as well as any speculative stock can.

Full disclosure: I hold PBR, and have seen a 250% appreciation in the past two years. But I still think it has a ways to go.
posted by googly at 7:55 PM on July 15, 2007

Bob Brinker had this question today and he said stay diversifiied.

I put $2000 in DBE last week, but I'm not really expecting much out of it, just an inflation hedge.
posted by Heywood Mogroot at 7:59 PM on July 15, 2007

one odd thing about Bob Brinker's answer was that he said energy is well-represented in the indices, so if you want an energy play just stay there.

While this is true, with $200+ oil I think it's entirely possible our entire economic structure will become centered on energy costs. . . especially land valuations, since these are entirely dependent on peoples' disposable incomes. . . in this case, "infill"
home builders (if such a thing exists) will be profit, and greenfield builders will get the rubber hose.
posted by Heywood Mogroot at 8:03 PM on July 15, 2007

Energy, which is synonymous with oil, affects every sector that people do business in.

Given your givens, I'd point out:

1) The companies that get oil out of the ground - XOM, COP, CVX, BP, PetroChina, etc - stand only to benefit from the fact that demand for their product outstrips supply. It's not really getting much more expensive to pump oil out of the ground, if the oil there to start with. The fact that oil goes from $70 to $100/bbl doesn't change the fact that it costs Chevron $4.62 (average) to get a barrel of oil out of the ground. You do the math. Adding to this is that the P/E ratios of these companies are historically very low - not because they've declined in price, but because of the gargantuan earnings they're raking in lately.

2) As oil becomes more expensive, a lot of industrial processes that depend on it will switch to natural gas instead; it's a natural substitute in some of these applications. Companies that get methane out of the ground and transport it will do well.

3) As oil gets more expensive, any alternative source of energy - hydro, nuclear, wind - get more valuable. Utilities that own a significant amount of non-oil based generation capacity would in theory enjoy a competitive advantage, except that they're regulated from competing with each other. However you can find niche investments that bring this into play.

For example, Olin corporation is in the chemicals business, making 'chlor-alkali' - in other words, splitting sodium chloride into lye and chlorine gas. This requires a lot of energy, and most chlor-alkali facilities meet this need with dedicated natural gas pipelines; Olin happens to have access to a convenient nearby hydroelectric plant. This means that in the past 5 years, while natural gas prices increased seven-fold, Olin paid no more for energy; they pocketed the difference, started paying a hefty dividend, and retained enough cash to last month acquire their next-largest competitor (pending FTC approval). If you look around there are more special circumstance opportunities like this, which in the end are based on rising energy costs.

4) Energy services companies - Halliburton, Schlumberger, Bechtel, Michael Baker - and companies that, for example, capitalize small-scale oil and gas recovery projects, like Prospect Capital, stand only to benefit as demand goes up.

5) Companies have a lot of bureaucracy and inertia that makes it difficult for them to implement change. Quite frankly with $100/bbl oil on the horizon, I cannot understand why GM would spend $1 billion on EV-1/Impact, and then kill that project in favor of filling giant parking lots with unsold Hummers, while Toyota merrily puts a Prius in every American garage. It really doesn't take a genius to see the American automakers putting themselves out of business.
posted by ikkyu2 at 8:16 PM on July 15, 2007

I'm with jackflash. Every financial adviser I have talked to preaches diversification. I am not fully confident that oil will remain the underpinnings to our energy needs as demand climbs higher and higher.

Neccesity is the mother of invention and you could wind up with peak oil being worth next to nothing if someone comes along with a killer, new idea for energy.

Your reasoning is spot on but speculation is a tough nut; especially if you want to go all in. If you were to of bet on horses being the transportation provider for humans 100 years ago you would of made a good, solid call, things being what they were at the time, but been in a tough spot 15 years down the road.
posted by bkeene12 at 8:20 PM on July 15, 2007

rmhsinc, I should probably clarify that I posted the above, not really as investment advice, but more to point out some things I've learned in the last year while idly poking around. I happen to believe much the same things you do and I was also curious to learn more about whether or not there was profit to be made from this kind of thinking. In my case I found that there was.

But the last thing I am is a stock tout; I would never feel comfortable advising anyone to buy any stock. If you wanted to learn more about these companies I mentioned or others, look over their balance sheets, etc., and eventually buy stock in them, that's your business, emphatically not mine.

Congratulations on your upcoming retirement. Your patients and colleagues will probably be sorry to lose you but I am sure that your new leisure will be well-deserved.
posted by ikkyu2 at 8:20 PM on July 15, 2007

Consider secondary effects. Everyone one knows the oil price will go up with peak oil. Some stocks already have that increase more than factored in, making them a risky play if the re is a positive surprise (new tech, new discovery etc.)
How about rail transport? I hear Warren Buffer just took a chunk of rail stock. With road transport disproportionately affected by fuel prices, and the market for shipping corn for ethanol, or even more coal for power, rail stacks up.
Sea freight probably does too.
In a similar vein, how about Telco? When I can't travel as much I call.
Is there a chain of small scale supermarkets in the US that are typically in walking distance of town centers? (In Australia I would say IGA).
While secondary effects will be less dramatic, they seem less risky than the direct stuff.
posted by bystander at 8:52 PM on July 15, 2007

If you want to benefit from peak oil, you should invest in things that are going to become more valuable once energy from oil becomes more expensive. The most direct route for that would be alternative energy sources: wind, solar, hydroelectric, biomass, nuclear, coal (though if we smarten up about carbon emissions and other pollution, coal will be used less), and natural gas. Find companies that own/harness these resources and invest in them.

You could also invest in companies that make energy efficient products, or that are well positioned to do so. Examples might include: rail transport, solar or ground-source heating, efficient cars, etc. Real estate is another option: my guess would be that increasing oil prices will increase the price of real estate in/near the centre of cities.

I don't think that oil is a great investment in your scenario: as oil reserves dwindle, the price will rise, but the cost of extraction will rise as well. Oil companies will make large profits for a while, but then volumes will decrease and other technologies and more efficient ways of life will (hopefully) begin to take over. Oil doesn't seem like a good long term bet in those conditions.
posted by ssg at 9:25 PM on July 15, 2007

The fact that oil goes from $70 to $100/bbl doesn't change the fact that it costs Chevron $4.62 (average) to get a barrel of oil out of the ground.

This assumes that Chevron (and compatriots) aren't hit with windfall profit taxes again, or just higher excise taxes intended to fall primarily on the firms owing to the relative inelasticity of demand for gas and oil.

I would not bet my retirement on this.
posted by ROU_Xenophobe at 9:32 PM on July 15, 2007

I am substantially convinced of the following:
upply will not meet demand and US and global industrial needs and infrastructure will continue to push oil in to the $100.00 bbl. plus ( and upward) within the next few years.

If you are substantially convinced that this will happen, then your most profitable bet is a long-term call. You can purchase a $74 call for $8.09 that, if the price of oil is $100 on November 17, 2009, will be worth $26 in two and a half years. If you want to be even more aggressive, you can buy twice as many $85 calls for $4 each, and those would be worth $15 each if the price goes to $100. That's a 275% return before taxes.

Greater returns are possible if you can also identify highly leveraged companies that only have a profitable business model if the price of oil skyrockets, and are thus undervalued now because the market disbelieves the Peak Oil theory. But with commodity options, your money is resting entirely on your own predictive abilities of the price of oil, rather than whether a particular set of business executives respond appropriately to changing market conditions or whether President Hillary Clinton decides to nationalize Exxon to satisfy the readers of Daily Kos and her trial-lawyer donors.

Of course, people who know much more than you seem to think that the contracts for such deliveries in November 2009 are only worth $73.75, and if they're right and you're wrong, that $74 call and $85 call will be worthless, and you'll have a -100% return on your money. But you said you didn't want to debate whether your assumptions were true.

If your assumptions are true because you've gotten a message from a time-traveller who saw the price of oil in 2009, then you should put every penny (minus three years expenses to live on while waiting for the calls to come into the money) into those calls, and triple your money. If it is less certain that you are correct, you should reduce your risk, portfolio exposure, and the size of your bet accordingly. Cf. Kelly's paper on the subject of optimizing wager size.
posted by commander_cool at 9:45 PM on July 15, 2007 [1 favorite]

How about rail transport? I hear Warren Buffer just took a chunk of rail stock. With road transport disproportionately affected by fuel prices, and the market for shipping corn for ethanol, or even more coal for power, rail stacks up.

Locomotives largely burn diesel. This doesn't mean that rails (or locomotive manufacturers) are bad investments, but it does mean that higher fuel prices aren't an unmitigated good for these firms.
posted by Kwantsar at 9:56 PM on July 15, 2007

Suncor (as googly mentioned) and the other oil sands stocks probably fit your bill, as a barrel of oil from the oil sands costs somewhere around $50 to get out of the ground. After making some necessary simplifications, we can see that these firms are 2.5x as profitable at $100 oil than they are at $70 oil. If the market thinks $100 oil is sustainable, those stocks probably do even better than calls on the commodity, unless of course you lever your commodity bet.
posted by Kwantsar at 10:05 PM on July 15, 2007

commander_cool laid out very clearly the most obvious investment, but you won't find me about to bet against the collective wisdom of the market.
posted by JackFlash at 10:17 PM on July 15, 2007

What commander_cool is saying is why bother trying to figure out all of the complicated consequences of $100 oil, guessing who will be the winners and losers and all the other unfathomable issues when you can simply bet on the premise of $100 oil itself. That is, if you believe the premise.
posted by JackFlash at 10:57 PM on July 15, 2007

1) The companies that get oil out of the ground - XOM, COP, CVX, BP, PetroChina, etc - stand only to benefit from the fact that demand for their product outstrips supply. It's not really getting much more expensive to pump oil out of the ground, if the oil there to start with. The fact that oil goes from $70 to $100/bbl doesn't change the fact that it costs Chevron $4.62 (average) to get a barrel of oil out of the ground.

Sure, but you can invest in companies that have rights to more expensive oil. For example, if you have an oil field that costs $50 to extract, and the price is $55, you're only making a 10% profit per barrel. But if oil hits $100, you'll be making $45/barrel, and your profit per barrel is multiplied by 9. There's obviously a big risk in that, though.

Locomotives largely burn diesel. This doesn't mean that rails (or locomotive manufacturers) are bad investments, but it does mean that higher fuel prices aren't an unmitigated good for these firms.

I'm sure they can burn biodesel if they'll need too.
posted by delmoi at 11:18 PM on July 15, 2007

I'm with commander_cool: if you really think that oil is going to spike to those prices in that timeframe, there's no need to do all sorts of indirect speculation. You can bet directly on the price of the oil.

The only reason to do anything else is if you aren't absolutely sure that the price of oil is going to be there, and you asked specifically that your premises not be questioned. Given that, the simplest approach would seem to be the one to go for.
posted by Kadin2048 at 12:26 AM on July 16, 2007

Personally I think it would unnecessarily risky to bet the skewing of your portfolio too heavily on peak oil being a correct hypotheses. See for example Steven Levitt's criticism of the theory for one prominent dissenter for example. An ordinary diversified portfolio may tend to do slightly less well then one that predicts what turns out to be the correct outcome - but you are risking backing the wrong horse.
posted by rongorongo at 3:55 AM on July 16, 2007

A friend of mine who works for a hedge fund says that trying to make investments based on this sort of prediction is probably not going to work out -- basically you are assuming you have more information than the market. Given the sharp increase in gas prices recently, it's probably not a wise assumption, unless you have more information than you're telling us ...
posted by Comrade_robot at 4:36 AM on July 16, 2007

I thought that once you hit 65 your supposed to go with the safest portfolio possible, that's your income for the rest of your life!
posted by furtive at 5:05 AM on July 16, 2007

Peak oil is pretty much beyond debate, but you should read Winning the Oil Endgame before you bet on oil prices heading heavenward. If you're still substantially convinced that your predictions are OK, then I have no advice for you.

From the abstract:

Fully applying today's best efficiency technologies in a doubled-GDP 2025 economy would save half the projected U.S. oil use at half its forecast cost per barrel. Non-oil substitutes for the remaining consumption would also cost less than oil. These comparisons conservatively assign zero value to avoiding oil's many "externalized" costs, including the costs incurred by military insecurity, rivalry with developing countries, pollution, and depletion. The vehicle improvements and other savings required needn't be as fast as those achieved after the 1979 oil shock.

If Lovins's analysis is sound (it generally is), and it really could cost less to eliminate oil from the US economy than it would to buy the oil so eliminated, and public policymakers cotton on to this and actually start doing something about it, then Peak Oil might not raise the price as much as you expect.

Investing in renewable energy technologies is probably a good medium-to-long term move regardless.
posted by flabdablet at 6:41 AM on July 16, 2007

Whose equipment is used in making hybrid batteries (OEMs/original equiment manufacturers sell to Ford, Toyota, etc.)? Bicycle companies. Bike accessory companies. Look into manufacturers of light rail trains. Who supplies these manufacturers?
posted by croutonsupafreak at 7:10 AM on July 16, 2007

Don't get me wrong: I think peak oil is a bunch of hooey. Julian Simon made a lot of money scoffing at similar predictions that the world would run out of natural resources by 1990. But the question asked us to assume that it was true (and presumably not only that it was true, but that the OP had knowledge that the rest of the market didn't have).
posted by commander_cool at 7:42 AM on July 16, 2007

Eggs. One basket. Not a good idea.

Consider also: your money invested in oil may end up being used to help fund lobbyists for Big Oil. Which is how we got into this mess in the first place.
posted by media_itoku at 11:15 AM on July 16, 2007

your money invested in oil may end up being used to help fund lobbyists for Big Oil.

Someone is unclear on the concept of fungible stocks and commodities.
posted by commander_cool at 11:30 AM on July 16, 2007

Thanks to all for the thoughtful answers--I can assure you I have no intention of abandoning the diversified and conservative portfolio I have--but I am willing to set aside 5-10% for more aggressive investing. Also, I am not planning on drawing down 7% of principal--I hope to do no more than 2-3% if that. I am banking on earnings of 4-7%. Thanks again for the thoughts. fca
posted by rmhsinc at 11:56 AM on July 16, 2007

A friend of mine who works for a hedge fund says that trying to make investments based on this sort of prediction is probably not going to work out -- basically you are assuming you have more information than the market.

This is a restatement of the Efficient Markets hypothesis. If you believe that the market immediately and accurately prices things according to the available information, which is what your friend is saying, then you can't beat the market because you think you know something it doesn't. Most buy-side investments assume that either the market has less information available to it than the buyer or the market has misinterpreted the information available to it. Fortunately, there's plenty of data showing that the efficient markets hypothesis is a myth and that Mr Market is an irrational nutbar subject to fits of unexplainable enthusiasm or depression.

As far as trading crude future options, one of the bad things about this is that it requires not only that the above predictions be correct, but that they come true by a specified time. One of the nice things about buying stock in Exxon (or other companies) instead is that you still reap some of the benefits if the predictions come true on time. If they don't, instead of losing all your money and being subject to a margin call, you end up holding stock in a giant company which is paying dividends and probably still making an operating profit. In other words the downside is a much more favorable outcome.
posted by ikkyu2 at 1:10 PM on July 16, 2007

One of the bloggers I deeply admire, Harry Newton, had a link to this article- which seems to be specific to your question.
posted by tfmm at 2:07 PM on July 16, 2007

Of course, people who know much more than you seem to think that the contracts for such deliveries in November 2009 are only worth $73.75, and if they're right and you're wrong, that $74 call and $85 call will be worthless, and you'll have a -100% return on your money

Price of oil barrel April 22, 2008 = $118US. Might have been a good investment.
posted by anthill at 11:42 AM on April 22, 2008