Greetings from my nice warm house (thank you central heating!) where I am writing you on my MacBook Pro laptop, both of which are here at least in part because of the power of today’s topic: oil and gas.
Today’s topic is a perfect example of the necessity for both yin and yang in your investing. You may be the best oil and gas stock picker in the world (yang: the focused strategy), but if you get the macroeconomic forecast wrong (yin: the big picture) you will be in a world of hurt. Both are absolutely critical to your success as an investor!
One of the most contrarian (and interesting) speeches from the Casey Conference was by Porter Stansberry, who predicts sub-$40 oil in the next 12 months and says that those who believe in Peak Oil “reveal a gross ignorance about the way that capitalism works”.
(Like Doug and Rick, Porter is not one to mince words!)
So today I present you with a true “Think for Yourself, Grasshopper” opportunity…Porter backs up his claim with some interesting facts, but what do you think?
Most experts disagree with him, but at the end of the day, the only opinion that matters is yours.
If Porter is wrong, he will simply come back next year and say, “Well, it looks like I was wrong on that one and lost the bet, here is the $2000 bottle of wine I owe you, Rick!” (he and Rick Rule like to place bets on these) whereas you will be licking your wounds (or celebrating wildly if he is correct!).
Porter is a really smart guy and has made some great calls in the past. However, one piece of advice that has served me well over my past 10 – 12 year journey toward financial independence is,
“The stronger the prediction and bolder the claim, the more caution is warranted.” — Kung Fu Girl
So let’s jump in…
Porter Stansberry Predicts $40 Oil
Technically, Porter’s presentation was titled “an update on the End of America” and he did discuss that briefly at the beginning:
End of America Update
Porter is still concerned that central bankers are running amok and believes that there will be a global hyperinflation soon—he doesn’t see any way out of the horrific global debt debacle without continuing to run the printing press (I agree).
He quoted Rick Rule’s famous saying, “paper money’s track record is unblemished—it has always failed!”, and updated us briefly on his predictions from last year:
- Last year he was very bearish, and instructed attendees not to buy stocks at all unless they were willing to hedge with short positions,
- To go long gold and long bonds as the only way to be truly liquid in a world of paper money,
- To short Europe (most notably Unicredit, the doomed Italian bank),
- To short First Solar, because “solar power doesn’t work” (he believes it’s completely uneconomical), and
- If you had to buy one stock, try MGM, because it owns the Las Vegas strip and gambling is generally a great business to be in and attractive to tourists.
He was more or less dead-on right with all of those recommendations, except for MGM, and still recommends shorting First Solar believing it will go all the way to zero (although he says it was a much better recommendation last year).
Quickly on MGM… Porter said that MGM has somewhere between $16 billion – $20 billion worth of property, but they only have about $2 billion in cash (they are highly leveraged). If they can pay off their debts, which he believes would be easier in an inflationary environment, then MGM will be in a good position.
However, all of that was really just a brief prelude to his main talk: the upcoming prospects for the oil and gas industry.
To sum up, Porter believes that Peak Oil is completely bunk and thinks that the same thing that happened to the natural gas market in the past several years (vast increase in supply due to new technologies causing a huge decline in prices) is now going to happen to oil.
Porter’s definition of peak oil is:
“When the U.S. has passed the point at which it will no longer be able to increase hydrocarbon production”.
Basically, those who believe in peak oil believe that oil production is going down and will never increase again, that demand is going up, and therefore that the price will continue to go up to infinity.
Porter, however, just flat-out thinks that is crazy, and that the Peak Oil scenario completely discounts human ingenuity and the free market laws of capitalism.
He put up a list of upcoming losers in the oil and gas industry, and proceeded to show us why he thought they will be bankrupt in the near future.
First he held out his basic assumptions, beginning with the fact that companies cannot stop “CAPEX” (capital expenditure) spending (this is the capital that must be spent each year on machinery and equipment such as drills, etc., and on maintaining those depreciating assets).
This CAPEX spending cannot stop because most oil and gas is produced in the first 12 months. After that first year, the rate of production for the well declines dramatically, so you must continually keep exploring and drilling new wells (which costs money…hence the need to keep spending on CAPEX).
He picked on Penn Virginia (NYSE: PVA) to illustrate what he thinks will happen to many oil and gas companies in the near future…
Porter’s Basic Assumptions:
- Assumes company cuts capital expenses by 75% per year going forward
- Assumes revenues remain where they are now and even grow 10% per year going forward (which is unlikely with price of gas under $2)
Porter calls these generous and conservative assumptions, and yet they still produce a three-year capital hole for Penn Virginia (which is basically the vast amount of money they will be losing):
“Capital hole” = Difference between what a company makes in selling oil & gas – what it spends in CAPEX – what it faces in debt maturities – what it pays in interest payments
And that difference in Penn Virginia’s case, that “capital hole”, is $1 billion!
This is four times their current market cap and $700 million more than their proven undeveloped reserves (PUD, which they could sell on the open market to generate cash)… in other words, this is a slow-motion bankruptcy.
Porter says that the company can avoid bankruptcy by diluting the current shareholders, and believes that is what you will see happen with most of the companies on his list.
He cut to the chase, basically saying, if you’re long oil & gas, you’re…um, let’s say “fracked”. (His word was a little more colorful)
Porter believes that by 2015, the entire global gas industry will change.
The U.S. will open 4 major LG (liquid gas) export facilities, which he says means that for the first time since 1949 we will become a major energy exporter.
He believes that this ability to export our excess gas will result in a change in the marginal price of gas around the world.
Right now gas in Europe costs $7 – $9 per MCF (volume of 1000 cubic feet, which is a little more than 1 million BTU or British Thermal Units, and a BTU is the heat required to raise the temperature of one pound of water by one degree Fahrenheit.)
And in Asia it costs between $12 – $14 per MCF.
Porter puts forth that we are the “Saudi Arabia of gas”. We will always be the largest and most developed producer of gas in the world, at least in his lifetime, and this means that we control the marginal price of gas.
(Basically, we have a huge supply of natural gas, and in the future we will be able to ship this gas to Europe and Asia where they will pay us dearly for it.)
Porter also pointed out another economic truism: that there is no such thing as a “glut of energy” because human beings have an enormous and unlimited capacity to use energy.
He believes that some companies might be able to save themselves if they can increase their liquid production fast enough (because gas must be in liquid form to ship overseas).
A Few More Points…
Historically, oil has traded at 6-10 times more than the price of natural gas, but today oil is more than 50 times the price of natural gas.
All of the technologies that led to the collapse of natural gas prices because of the huge surge in production are now happening with oil (horizontal drilling, hydraulic fracturing (“fracking”), 3D seismic).
5 years ago, the United States had 15 billion oil barrels of proven oil reserves. Today, however, there are three large shales currently in production, where the largest drillers claim there are more than 25 billion barrels in reserve. Apparently this is not official yet because the government won’t recognize it, but Porter has spoken with the CEO of Continental Resources (who have drilled many holes in the Bakkans) and a friend of his who has personally drilled at Eagle Ford.
So, Porter holds out that our current supply of 15 billion barrels will increase to between 60 – 100 barrels and the price of oil will collapse.
4. Seaway Pipeline Reversal
They are reversing the Seaway pipeline that runs from Cushing, OK to the Gulf. The flow of this pipeline has never been outbound; it has always been inbound from the Gulf. Porter believes that this sets the stage for the U.S. to become a major exporter of natural gas and petroleum products.
5. Goldman Sachs (Yes, that Goldman…)
Goldman says that the U.S. will be the leading producer of hydrocarbons by 2017, producing more oil & gas than Saudi Arabia.
6. Entrepreneurs vs. States
Porter also pointed out an article by Phil Verleger, a leading authority on the oil and gas markets, in the Financial Times last Tuesday. Here is a link to the article (unfortunately you must be a subscriber to read). I can hit the highlights for you though—the article is titled, “The coming US boom and how shale gas will fuel it”, and more or less echoes Porter’s points above.
Additionally, Mr. Verleger brings up an interesting fact about the differences between our U.S. oil and gas industry and the rest of the world. Our oil and gas industry is highly fragmented and led by hundreds of small entrepreneurs. In contrast, the rest of the world’s oil and gas industries are led by giant state-owned monopolies.
Porter of course put forth the question…who do you think in the long run will produce more oil & gas?
7. Property and Mineral Rights
Additionally, the property rights are different in Asia and Europe than they are in the U.S., and in many countries it isn’t possible to separate the mineral rights from the land, giving the U.S. a big economic advantage.
It will take decades for Europe and Asia to match our infrastructure…all of the natural gas pipelines are owned by Russia, and you can compare the 100 rigs in Europe vs. the 2000 rigs in the U.S.
Porter’s “Moral to the story” is that capitalism and free markets work. When you have an expensive resource in high demand (like oil…), capital pours in, and prices will fall sooner or later. Economics DO apply to oil and gas, too! Therefore oil prices are going to go down, because production is going to go up.
He wouldn’t buy oil at all right now, and would only buy gas if he was buying the company out of bankruptcy and had a very solid way to hold it for a 3 or 4 year period.
Porter concluded by saying that declining oil & gas prices are horrendous for us as investors, but are great for our economy. He hopes we (the U.S.) will use the coming boom to repair our balance sheet…(but he pointed out that hope springs eternal!).
What do you think? $40 oil or $100 oil?
This is a pretty important macroeconomic question if you are considering investing (or are already invested!) in the oil & gas industry.
If you would like to get the other side of the equation, I encourage you to read a rebuttal from Marin Katusa of Casey Research, posed in yesterday’s Daily Dispatch—you can read Marin’s “10 Reasons Why Porter Stansberry is Dead Wrong” (or something like that…) here!
Also, they released the audio for the Conference so if you’d like to listen for yourself (which I highly recommend) you can order the entire collection here. (I am unaffiliated, just a happy customer!).
Then please let me know what you think in the comments!
Thank you so much, and please also let me know if you are enjoying these reports or would prefer I move on to something else… thanks!
To your financial success,
—Kung Fu Girl
Want to master your finances? Join us now.
Why don't you join our community on your journey to financial mastery.
Sign up below for the FREE Kung Fu Finance newsletter.