Buying Oil on Sale as U.S. Dollar Gets Weaker

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The weaker the U.S. dollar gets against currencies, the more sense it makes to buy oil on sale. If you’re buying your oil in dollars – and you have to these days since oil is priced in dollars – a weaker greenback makes oil cheaper. Mind you it only does that as long as the oil price doesn’t go to the moon. And it’s not quite doing that yet.

Oil did move up overnight in the futures market to US$71.94. And locally, there was more positive news for energy and energy stocks. Bloomberg reports that, “LNG sales from Australia’s biggest resources project may reach A$300 billion over its first 20 years.” It added that, “Chevron yesterday completed supply agreements with Tokyo Gas Co., Osaka Gas Co. and South Korea’s GS Caltex Corp. that [Aussie Prime Minister Kevin] Rudd valued at A$70 billion. The Japanese companies have agreed to buy a combined 2.25 percent stake in Gorgon.”

The Prime Minister would be keen to associate himself with the success of Gorgon. Who wouldn’t? It’s a big deal. It’s also a dirsuptive deal.

Earlier in the week – prior to being struck down again with an intestinal virus – we reviewed the negative comments on unconventional LNG from Woodside Petroleum’s Don Voelte. He pointed out that the capital spending and operating costs for the coal-seam-gas business were probably higher than people realised, and that there were real problems with higher carbon dioxide levels and other by-products from unconventional gas (compared to conventional off-shore LNG).

Voelte may be a bit frustrated that investors are taking a punt on the small companies in the LNG business that have yet to produce anything, instead of say, chucking some cash into his firm. After all, Woodside remains one of the best established LNG producing stocks in the world. That’s why we featured it in Diggers and Drillers a few years ago.

But he was wrong to imply that unconventional LNG can’t be economic or competitive. It can. An example is the production of unconventional reserves from the Barnett Shale formation in Texas over the last two years. Yes, it was capital intensive. But it – and other ‘tight gas’ projects – increased gas production in the U.S. over the last three years. That reversed a long period of stagnation, with natural gas production having peaked in the States in the early 1970s.

Unconventional Gas Projects Boost U.S. Production

So the financial and business model for succeeding in the unconventional energy space is already there. For Australia, that makes the prospect for investors even more exciting. Not that it will be easy. But at least you know what you’re looking for. You’re looking for geographic regions that are highly prospective for either “tight gas” (natural gas stranded in semi-porous structures) or coal-seam-gas, most of which is being found in Queensland’s Bowen and Surat Basins.

Once you find the companies that have the best prospects, you look for the companies that can produce those prospects at the lowest cost. You’d also look at the capital structure to make sure the firms can execute their projects without a lot of debt, and preferably with a cash cushion. You’d look for good managers too.

None of this still guarantees the company will succeed or the share price will rise. But if you want safer integrated energy plays, there are already plenty of those to choose from. And all those firms are valued on production and reserves, meaning that the upside (in terms of share price) is strictly correlated with rising oil prices.

The case with the unconventional energy plays is different. First, the big institutions aren’t looking for these firms. They don’t want to take a punt on unproven company in an unproven industry with high capital costs and high probability of failure. The advantage for finding the eventual winning firms goes to small investors simply because bigger investors can’t be bothered to look until later, after the winners emerge (by which time the largest share price gains will have already occurred).

But the main advantage of looking at the smaller firms is that they are emerging as the disruptive technology firms of the energy sector. It is true that technology can increase production from oil and gas fields and help us find more oil and gas. We don’t think this means that better technology means there is no oil crisis.

However the smaller, entrepreneurial companies are probably the most exciting energy stocks because their success is so unexpected. As Ingrid Campbell writes in “A overview of tight gas resources in Australia, “The defining feature of the history of tight gas exploration in North America has been the high level of scepticism by the major global oil and gas companies towards the commercialisation of this unconventional resource. It was, and is, the smaller independent explorers, who were motivated to develop the techniques and technology for extracting gas commercially from tight reservoirs.”

Small companies with everything on the line had better be extremely motivated. If they aren’t, they’ll fail. And frankly, most of them do. But the ones that don’t, well they often do very well indeed. And that alone is the best reason to keep looking at these stocks, as Kris Sayce has with his “thin air” plays at the Australian Small Cap Investigator.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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2 Comments on "Buying Oil on Sale as U.S. Dollar Gets Weaker"

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Ross
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For the AUD interested I suggest a look at the 1 year AUD-CAD and juxtaposed on the 1 year AUD-USD. Also past week AUD weakness on tne crosses.

Ross
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