Oil Prices Under $70

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Whiplash. Down six percent one day. The S&P/ASX 200 futures up 223 points the next. All signs point to big rally in the Aussie market.

Do you get the feeling investors have no idea what to do? It would be a pretty common feeling. Yesterday’s action makes it seem like the idea the idea of a synchronised global recession is just now occurring to investors.

But then, the Dow gyrated all day long, before closing up 400 points to 8,979. The signals were decisively mixed. What about here in Australia? It was a historically bad day for the big miners. But you’d have to think Rio Tinto and BHP are starting to look over-sold.

Well, you wouldn’t have to think so. But it looks like it nonetheless. There was a strong whiff of desperation, margin calling, and capitulation in the air yesterday. So what gives?

First the numbers. BHP, at $25.80 a share, is trading at just 5.7x projected 2009 earnings. The company hasn’t moved the guidance for those earnings lower, although investors clearly seem to think this will happen. The company has US$4.2 billion in cash and just $12.6 billion in debt.

Rio trades at $66.01, or just 5.3x expected 2009 earnings. It has US$2.4 billion in cash. It does have US$43.8 in debt, $40 billion of which it took on to finance the deal with Alcan. Earlier this week, Rio said it was delaying $10 billion in asset sales and cutting back aluminium production.

Investors punished the China story yesterday, sending Rio down 16% and BHP down 13%. Goldman Sachs cut its forecast for Rio’s 2009 earnings, citing Tom Albanese’s comments earlier this week that marginal Chinese steel producers would reduce demand for iron ore. For its part, BHP faces concerns that increasing production at Olympic Dam (especially copper) is going to take longer and be more expensive than it originally planned.

But keep in mind Rio did not say it was freezing all capital spending. It’s reviewing short-term projects, but not revising long-term capital spending goals. The company still believes demand for base metals and bulk commodities justifies spending billions on new projects. Ditto for BHP.

The trouble is in the short term. Because it’s been unable to sell the assets as planned, it will have to pay down some of the debt that matures in 2009 with cash flow. That’s less money available to shareholders. And you know what they say; you have to spend money to make money. If you’re spending money to pay back money, you’re not making money.

Still, the real issue here is whether investors have lost total confidence in the China story. And just what investors are we talking about anyway? Mums and dads? Hedge funds? Aussie institutions? Global fund managers?

We don’t typically fish at the end of the pier where the blue chips are. But Rio and BHP are currently priced for a bad 2009. And it wouldn’t surprise us if they may make new lows with the market. But in our Robinson Crusoe portfolio of stocks you’d want to own if you were on a deserted island for the next ten years, one, if not both the companies, would be on the list.

What about Woodside Petroleum (ASX:WPL)? The company reported yesterday that third quarter revenues were up by 84% over last year. Higher oil prices (year over year) and a production increase are what delivered the gaudy number. And going forward?

Woodside would have to set a final quarter production record to reach its goal of 86 million barrels of oil equivalent this year. It looks like that number will come in between 81-84mboe. That was enough to send the stock down 5.5% on the day to $37. It’s down 47% from its high in May.

One other reason the stock probably fell is that the company studiously avoided saying anything about global oil prices or a global recession. Oil futures were down almost US$6 in New York trading to close at $69.85. That’s the first time oil’s closed below US$70 since August 23rd of 2007.

Is Woodside a Crusoe stock? Well, it depends on what your long-term view of energy is, doesn’t it? In the short-term, the whole planet is having a recession. Oil prices could go lower. Woodside’s stock price would probably go lower, too. By the way, if you have your own “Crusoe Stock” suggestions, send them to us at dr@dailyreckoning.com.au.

In the long term-at least the part before we are all dead-we reckon this global recession is a bit of a reprieve for anyone who hasn’t taken Peak Oil all that seriously. Demand growth for crude is going to slow. A world less busy uses less energy.

But don’t think it will last forever. Today’s oil production comes from oil fields that were discovered decades ago. That same is true for many other commodities. We are harvesting the bounty of previous exploration.

As demand resumes growing-in one month, one year, or two years-we’ll be right back up against the problem markets began to price in last year: declining oil production in the world’s major fields side-by-side with growing demand from the emerging markets.

With the emerging markets currently submerged by recession fears, the oil issue comes off the boil for a bit. Oil stocks too. This gives you an excellent chance to ad companies that throw off huge cash flows when energy prices rise. And in our view, energy prices are going to rise again and by a lot in the coming years.

By the way, thanks for the many helpful notes and offers for help with our new super annuation project. If we don’t get back to you right away, please don’t take offense. The response was large, so it’s going to take a few days to sort it all out. But it’s good to know there are so many people already taking control of their investment future among the Daily Reckoning’s 40,000 Australian readers.

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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