Tuesday, September 05, 2006


The Gulf Oil Gusher I wrote about a few days ago is the lead story at CNBC this morning. The size is now estimate to be 15 Billion Barrels; the biggest discovery since Prudhoe Bay, Alaska. This increase doubles US domestic proven reserves.

Actually, it is common knowledge that our biggest reserves are in shale deposits in Colorado, Wyoming and Utah. These reserves are estimated to be one to two TRILLION BARRELS. One of the six companies that are testing extraction techniques has applied for patents on a process that can extract the oil from for $25 per barrel or less. Not to be out done, another firm claims that it can extract the oil for less than $10 per barrel. The words could be hyped in an attempt to win future government contracts. In any event, it will be several years before commercial quantities of oil are flowing from shale. The good news is that new oil is flowing from all around the globe, significant production has recently come on line and much more will come on line in 2007, 2008 and 2009.

Devon Energy, one of the stake holders in the latest Gulf Gusher, has restored 90% of production lost due to Katrina. It will most likely abandon the other 10% as being "played out" and use the equipment on this new discovery. During 2007, Devon , expects to begin production at its Merganser Gulf Project, at its Polvo project in Brazil and at its ACG field in the Caspian Sea. The firm also recently paid cash to purchase the Barnett Shale field that is being developed.

There are scores of other exploration and development companies followed by Standard and Poors and many of them are rated buy or strong buy. The reason most are rated buy is because, in addition to having strong earnings, they are having success finding more oil. I do not recommend these companies. The earnings are high but not likely to grow by much. Each drop of new oil is an increase in supply. The car ads this Labor Day Holiday were very different from last year. Last year, the focus was $12,000 discounts for monster SUV's. After the $12,000 discount the total price was still "big money". This year, there were scores of small car models offered and the total price of many of them was less than $12,000. Two years ago, people were paying above sticker for hybrids. The small cars being sold today get "approximate hybrid mileage" but cost half as much and in some cases 90% less.

The bottom line is that supply-demand relationships have changed. Demand growth has slowed and supply growth has increased. Using two major companies to support the point: Exxon-Mobile replaced 116% of reserves over the past 3 years and will soon start the second phase of a major gas development in Qatar, while Ford Motor is closing down a number of low mileage truck production lines.

The "bears" say the decline in oil price is due to the "coming recession". While it is true that world wide economic growth has slowed, we are no where near a world wide recession. In the US, companies are increasing research and development spending. Companies simply do not spend on R&D when they see a recession on the horizon. Business in many areas is booming.

The bears growl about stagnant wages while nursing positions offering as much as $50 per hour are going begging. America has exported many low wage jobs but there are various high wage jobs in various industries available; lawyers are in high demand and software developers and petroleum engineers can right their own ticket! The bears counter that these are not manufacturing jobs which is similar to the bears arguments 100 years ago when farm jobs were being lost. America grows more food today than ever before and America produces more goods today than ever before. American exports are going out the roof!

My reason for writing about the Gulf Oil Gusher and the strong economy in the same email is to demonstrate that it is not time to run for cover. Among the top performing stock sectors for the past three months have been defensive sectors such as consumer staples. Economically sensitive stocks, including transports and interest rate sensitive stocks, including home builders have done poorly. The likelihood is that home construction will not bounce back to the old highs any time soon but the transports will. Using airlines as the proxy for transports, the fear for airlines has been that the slow down in the economy would decrease traffic enough to more than off set the benefit of lower fuel prices. The numbers show that even after the latest terrorist plot and the resulting long lines at airports, traffic did not slow much. Continental ended the month of August with a 9.3% increase in revenue passenger miles and another increase in its load factor.

The decline in fuel prices should send hundreds of millions of dollars to airline bottom lines. The airlines will not give up most of the recent fare increases. The situation is less flexible than what is happening at gas stations. The wholesale price of gas is down to $1.70 which implies the retail price should be $2.20 but the stations will drag their feet getting there. (I was pleased to purchase gas at $2.54 per gallon during the holiday week end.)

The bottom line is gas prices and inflation in general will be tamed in the months ahead, while the economy gets a boost from the billions of dollars not spent on oil. This money will be spent on other things. Hold onto your hat because this is a great situation for stock holders to enjoy.