At $50 a barrel oil vs. $100 a barrel:
1. High-cost alternatives hydrocarbon like liquefied natural gas (LNG), where projects require billions of dollars in spending on infrastructure–cryogenics at the wellhead, special refrigerator ships for transport–become much less compelling. Tar sands, too.
2. Green energy substitutes like wind and solar, which already require heavy government subsidy to encourage adoption, are less attractive, as well
3. The real asset value of oil companies is in their proved reserves. A lower price hurts this value in two ways. The first is the obvious one, that the selling price of output is lower. But there is a second. In order to be counted as reserves, barrels of oil must be economically recoverable at present prices. So quantities may shrink, too, as the price declines. One can imagine, say, a tar sands company that has one hundred million barrels of reserves worth $20 billion at a $100/bbl price …but 0 barrels worth $0 at a $40 price.
4. The natural gas price in the US has fallen, but not by a much as oil. This puts US petrochemical plants, which use natural gas as a raw material, at a relative disadvantage vs. their European and Asian counterparts that use naphtha, a petroleum product. In absolute terms, the US companies are still in better shape, but to the extent that their historical price advantage has long ago been factored into stock prices, their equities have been relative underperformers.
5. I spent six years as an oil analyst, covering both the big internationals and domestic explorers, and another while managing an Australian portfolio at a time when over half the market consisted of natural resources stocks.
Admittedly, my expertise is dated. Nevertheless, some things don’t change. Hearing and reading Wall Street “experts” on oil publicizing their opinions, I’m struck by how much loss of basic knowledge about the oil industry there has been within the investment community over the years. This really shouldn’t be so surprising. I’ve seen the same phenomenon in the mining industry. In both cases, there have been very long stretches of time when the relevant stocks have been dormant and, consequently, it has been very hard for a sector specialist to make a living selling his analysis.
More on industry sub-sectors tomorrow.