What if Past is Prologue?


My investment letter, Outstanding Investments, looks for opportunities in resource plays. Hence, our portfolio is chock-full of oil and gas companies, uranium diggers, gold and silver miners and technology companies that enable basic resource production.

This resource focus has been working very well for the past decade – and it’s not just me saying it. The authoritative Hulbert Financial Digest recently ranked Outstanding Investments as No. 1 in overall return from 2000-2010 among 98 investment newsletters.

According to Peter Brimelow, of the Dow Jones publication MarketWatch, “The decade’s top performer is a hard-assets bull… Over the past 10 years, Outstanding Investments was up an absolutely stunning 21.66% annualized by Hulbert Financial Digest count, versus 2.33% annualized for the dividend-reinvested Wilshire 5000 Total Stock Market Index.”

To place this in perspective, Mr. Brimelow explained that Outstanding Investments is “easily [Hulbert’s] top performer over the decade – the second best, The Dines Letter, was up 14.7% annualized.”

It’s an honor to be the editor of a newsletter that’s ranked so highly by an independent third-party reviewing service. And it’s humbling to be out in front of such a strong field of competitors. It makes me want to work even harder to find more great investment ideas for Outstanding Investments readers.

So where do we go from here?

I believe that the fundamental Outstanding Investments investment idea – looking for resource plays – will carry over into this new decade. In other words, many of the same factors that shaped the investment climate during 2000-2010 will still be at work in the next 10 years.

More specifically, I don’t see any looming large increases in supply for most energy and mineral products. If it happens, then increased supply will tend to drive down prices and undercut the long-term benefits of resource investing. But I don’t see it happening.

Also, still, I’m deeply concerned about future shortages of many forms of energy and minerals. The world’s population is growing, and many millions – billions, actually – of people are moving up in their ability to demand and afford things that require energy and minerals.

So I see rising future demand, accompanied by shortages of many things in many areas. These forecast shortages support the long-term trends in pricing strength and, by association, the Outstanding Investments resource-investing thesis.

Let’s drill down a bit more. Why do I see problems – and investment opportunities – ahead for energy and resources? I keep an eye on major resource development stories from across the world. Whether it’s oil development offshore Brazil or Australia or mining projects in Africa or Central Asia, I see many common themes.

First, there are very few new high-grade energy and mineral deposits being found anymore. For as big as it is, the world is well mapped and explored, if not picked over. If there’s a “new” high-grade ore or energy resource – and there are some – it’s likely difficult and expensive to access.

For example, one of the highest-grade new copper developments in the world is in Afghanistan. It’s a huge deposit, with high grades, but it’s subject to the vagaries of the ongoing warfare in the South Asia region. It’s important to note that the Chinese are developing this deposit, and the eventual output will likely ship out to China.

Or consider the difficulty of developing the oil deposits recently discovered off Brazil. Yes, there are immense new oil resources in the Brazilian pre-salt plays. But any developer – such as Petrobras (NYSE:PBR), Statoil (NYSE:STO) or Hess Oil (NYSE:HES) – will have to stage expensive ships up to 200 miles offshore and drill four-mile deep wells after lowering risers and drill pipe into as much as 10,000 feet of water. Overall, the Brazil oil play will require a monumental effort, which I’ve addressed in many Outstanding Investments articles over the past couple of years.

This gets into the second major issue for future resource supplies. The costs of development are large and rising, to the point where the sticker shock is stunning.

A deep-water drilling rig – such as one of the massive vessels owned by Transocean (NYSE:RIG) – costs over $1 million per day to lease and operate. When you add in the costs for designing, building and installing subsea production equipment – such as the equipment manufactured by FMC Technologies (NYSE:FTI) – a deep-water oil well can cost in the range of $150 million and more. A major deep-water, multiwell oil development, such as the Perdido project of Shell Oil (NYSE:RDS-B) in the Gulf of Mexico can cost in the ballpark of $10 billion.

It seems like many resource developments come in multiples of half a billion dollars or so. For example, not long ago, I visited a major new project to develop potash fertilizer, and the “basic” construction number was over $600 million for the mine setup. Or consider a new facility to process rare earths currently being built in Malaysia at a cost of over $500 million. I’ve reviewed plans for upgrades to several major US pipelines, and the price tags are in the range of a billion dollars for every hundred miles or so.

It all adds up, and it adds up to very big numbers. For many future resource developments, capital costs alone may turn into showstoppers. It’s important to keep an eye on this critical metric.

A third major issue for resource development is time. Everything in this arena takes time, on the scale of years, if not decades.

A relatively straightforward oil sands development in Alberta can take five years from the feasibility study to delivering the first oil. And that’s if all of the permitting and financing goes well, with no major interruptions.

Another issue that affects project development is personnel. For a variety of reasons that date back over many years, there just aren’t enough trained people to run all of the world’s major resource development projects.

There’s one more issue that affects resource development and future availability, and that’s political interference. One clear example of national-level mismanagement, affecting current and future resource availability, is in Venezuela. There, Generalissimo Hugo Chavez has utterly politicized the state oil company, PdVSA.

Over the past 10 years, Gen. Chavez fired many former oil workers and packed PdVSA with loyalists. Also, he forced PdVSA to divert capital from oil development into social spending. The result is clear, with PdVSA oil output falling from 3.3 million barrels per day (b/d) in 1998 to the current level of about 2.25 million b/d – despite the utterly immense hydrocarbon resources of Venezuela.

Gen. Chavez also nationalized some foreign-owned oil and related energy operations in Venezuela. This has led to a precipitous decline in foreign direct investment in Venezuela’s oil sector. Many talented firms and people simply fled or avoided Venezuela to work in other countries and regions.

Falling oil output, and a mercurial investment climate, has hurt overall revenues flowing into Venezuela, as well as contributed to tighter world markets for oil. In an indirect way, Gen. Chavez’s actions support high world oil prices and create new energy and resource investment opportunities elsewhere.

Thus, with things the way they are right now – low grades, high costs, long timelines, limited personnel and national-scale mismanagement – I foresee something that may seem a bit odd to say: There are many more years of profitable resource-investing ahead of us.


Byron King
For Daily Reckoning Australia

Byron King
Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments.

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