At the latest Casey Research conference, respected investment
analyst Porter Stansberry stood at the podium and predicted that
the price of oil will fall below US$40 per barrel within the next
12 months. Part of his reasoning revolves around the impact that
the shale gas revolution has had in the United States - he believes
a similar thing will happen with oil.
Porter is a friend of mine and a very smart, successful
individual … but I think not.
From my perspective, the pressures at play in the oil market are
all pushing prices in the opposite direction: up. Global supplies
are tightening, costs are rising, and demand is not falling. Prices
are going to remain high, and then go higher. And there will not be
a shale oil revolution anytime soon.
I'm the kind of guy who puts his money where his mouth is, so I
challenge Porter to a bet. I bet Mr. Stansberry that the price of
oil will stay above $40 a barrel over the next 12 months. The
wager? 100 ounces of silver.
Porter has made a lot of good calls in his career. I highly
recommend watching his video
The End of America
, an interesting and entertaining look at his prediction that the
U.S. will soon drown in its debts and cease to be a global economic
powerhouse, a transition that will lead to riots across the
Porter and I agree on a lot of things, but on this one he's
wrong. Below are my top ten reasons that high oil prices are here
Reason 1: "The Big Pinch"
Oil production levels, as well as exports, have been falling in
most of the world's top ten supplier nations:
(Click to enlarge)
The "Seven Sisters of Declining Exports" - Saudi Arabia, Iran,
Nigeria, the UAE, Norway, Venezuela, and Kuwait - share one common
characteristic: their oil fields are old. Oil fields don't produce
the same amount year after year. They decline significantly from
one year to the next because each barrel of oil taken from a
reservoir reduces the pressure within the field, leaving less force
available to push the next barrel of oil up the well. But don't
take our word for it. The following chart shows production from
Alaska's North Slope oil field in the past 30 years:
(Click to enlarge)
Another example? The Cantarell field in Mexico, which produced
2.1 million barrels per day in 2003, produced just 400,000 barrels
last month, a staggering decline of more than 80%
in just nine years
To maintain output levels, producers need to consistently invest
huge amounts of money and time in exploration, development of new
areas, and engineering and utilizing new technologies to extend oil
field lifespans. All of this costs money, and lots of it. Of the
Seven Sisters of Declining Exports, six are countries where the oil
machine is run by a national oil firm. That means that revenues
from oil exports belong to the government … and those governments
are stuck between a rock and a hard place.
They know they need to direct the oil revenues back into their
fields very soon, before they decline beyond the point of repair.
In the meantime, production levels continue to fall. Compounding
the problem of declining production is the fact that most of these
countries have long relied on cheap domestic fuel prices to keep
their citizens happy. This has spurred rising consumption in many
oil-producing countries, including Saudi Arabia, Iran, Nigeria,
United Arab Emirates, Venezuela, and Kuwait.
With domestic consumption climbing and production falling, these
countries have less oil available for export every year. But here's
the hard place: oil export monies make up the vast majority of each
government's revenue. They
to sell oil on the international market in order to fund their
day-to-day operating expenses. And their operating expenses are sky
high: these governments constantly make new social-spending
promises to appease their masses; and since their populations
continue to grow, these commitments grow larger with each passing
Venezuela is a prime example. Hugo Chávez owes a big chunk of
his popularity to the domestic fuel subsidies that render fuel
prices in Venezuela among the lowest in the world - it costs just
US$0.18 per gallon to fill up in Venezuela, and that's ridiculously
expensive compared to the US$0.05 per gallon it cost a year ago.
Yes, that means you could have filled your car for $1 in
Getting rid of these fuel subsidies would solve part of the
problem, but it is simply not doable - it is not just political
suicide, but a sure-fire way to incite riots and social unrest.
Just a few months ago Nigeria's government tried increasing
domestic gas prices; the country rapidly descended into violence as
protestors demanded a return to subsidized fuel. The government
relented within days.
Fuel subsidies are not the only expensive item on many a
government's social-spending list. Housing, food, health care,
education - these are all burdens that socialist-tending
governments take on to cement support. Social spending is a great
way to make yourself popular with your citizens, but it is also a
great way to bankrupt your country … unless, of course, you can
sell oil at high prices to other countries. According to our
analysis, OPEC nations need the price of oil to stay above $60 per
barrel to pay for all their social programs. In other words, they
need $60+ oil to stay in power - and you can be certain they will
do everything necessary to make sure this happens.
To sum it up: Governments in most of the world's key oil export
nations need more money from fewer barrels of oil, and it is a lot
easier to hose your international customers than your own citizens.
This results in "The Big Pinch."
What is "The Big Pinch?" In simple terms:
Declining production + increased domestic demand = Less oil
available for export
Revenues from oil exports must at least remain stable, if not
increase, to meet domestic budget needs
Oil export prices must increase.
Reason 2: Natural Gas and Oil - Different Markets,
Natural gas and oil are both hydrocarbons, and analysts
frequently discuss the two as if they are one and the same, but
they are very different commodities with completely separate market
mechanics. To summarize: oil is a
commodity while natural gas is a
Natural gas can only travel via two methods: through pipelines
and as liquefied natural gas ((
)). Engineers have come a long way in building pipelines that
traverse thousands of miles or run underneath bodies of water, but
pipelines are still limited in their usefulness - we're never going
to build a pipeline from Norway to Japan, for example. The only way
to transport natural gas across oceans is as LNG.
In its gaseous form, natural gas takes up far too much room to
ship economically, so LNG is natural gas that has been condensed to
liquid state. On conversion into a liquid the volume shrinks to
just 1/600 of its original size, making it economic for
transportation. Unfortunately these liquefaction plants easily take
several years and billions of dollars to build. Also, not all
gas-hungry countries can take LNG - they must have a regasification
facility that accepts the LNG, turns it back into a gas, and sends
it through pipelines to consumers.
Many energy-hungry countries, such as Japan, Korea, and Taiwan,
have built the necessary infrastructure and are taking all the LNG
they can get their hands on. Their competition for LNG cargoes has
driven LNG prices far above basic natural gas prices. A quick
comparison: Japanese natural gas trades at $16.8 per MMBTU, whereas
Henry Hub trades at just $2.11.
What does this mean? Countries with natural-gas-liquefaction
facilities are able to get top dollar for their gas in the global
market, while countries without LNG capabilities are at the mercy
of regional supply and demand.
What about the United States? The United States has no LNG
liquefaction plants - the last operating facility, the Kenai plant
in Alaska, closed in 2011. This means that the flood of shale gas
production in the U.S. will continue to overflow storage facilities
and depress US natural gas prices, because domestic demand is not
rising as fast as production and there is no other way to get the
gas to customers across the oceans who want it.
Oil, however, is a very different story. A barrel of oil
produced in Saudi Arabia can be shipped to the United States and
sold on that market. This means that if oil cost $10 in Saudi
Arabia and $50 in United States, some enterprising business would
take oil from Saudi Arabia, ship it to the United States, and sell
it for a profit. Of course, the real picture is a bit more
complicated than that. Prices do differ somewhat from place to
place - Western Canada Select crude, for example, currently sells
for $88.98 per barrel, while Brent Crude is priced at $119.17 per
barrel - but such divergences simply reflect the costs and
constraints of transportation and the range of crude-oil qualities.
The general idea is that oil is a global product. As such, dramatic
increases in supply in one part of the world can be sold off
elsewhere in the global market, creating much less impact on the
producing region than with regionally constrained natural gas.
This means that while a rapid increase in natural gas production
pummeled gas prices in North America, the same would not happen to
oil prices in North America or elsewhere if US oil production
An example might help put things in perspective. US natural gas
production grew by 30% in the past five years due to the shale gas
revolution. If US crude oil production grew by 30%
, that would add three million barrels a day to global production.
Even though this sounds like a lot of oil, it would represent just
4% of the global supply.
World crude oil production rose 4% from 2003 to 2004. What
happened to the price of oil?
Reason 3: Natural Gas is Not Oil
One of the main arguments Porter uses to support a falling price
of oil is that the world's newfound abundance of natural gas is
providing an alternative fuel for the future. While there is some
truth to that statement, there are more caveats than
There is no way natural gas will replace even a fragment of oil
demand during the time frame in question, which is the next 12
months. Oil is entrenched as the world's mainstay fuel; gas has
always been second or third on the list of energy-resource
importance. Changing the ordering on that list will take decades,
if not generations. How many natural gas fueling stations do you
drive past on your way to work? Not many, I'd bet, especially
compared to the number of gas stations in your neighborhood. Do you
see that ratio changing much in just 12 months?
In addition, it's easy to forget that we rely on oil for far
more than just fuel. Look around you - chances are good that at
least half of the items you see from wherever you're sitting
include at least some oil. We use oil for concrete, shingles,
pipes, ink, synthetic fabrics, crayons, computer cases, carpet,
paint, Styrofoam, shampoo, helmets, electrical insulation,
toothpaste, lipstick, tires, rope, fertilizer, candles, adhesives,
refrigerants, artificial turf, pill capsules, soft contact lenses,
shaving cream, antifreeze, antihistamines, insecticides, fan belts,
hand lotions, caulking, golf balls, credit cards, Formica,
footballs, bandages, medical tubing, packing tape, and many, many
Oil is a deeply ingrained part of how our world operates, and
demand will continue to rise with population for many decades to
come. It will take many years for natural gas to even start to
supplant oil as the dominant fuel.
Natural gas will play a growing role in the world's energy
scene, but the timeframe for the shift is very long. Twelve months
from now natural gas prices in North America will still be
depressed and global oil demand will be almost the same as it is
Reason 4: My Country, My Oil
I believe we are in the early stages of the "Decade of Resource
Nationalization." As supplies tighten, natural resources of all
kinds will become more and more valuable. Whether to control
additional revenues or to secure domestic supplies, governments
will nationalize natural resources with gusto.
The latest example of this is Argentina. A beautiful country
with incredible geological potential, Argentina's resources are
wasted on a government that is simply unable to incentivize private
investment in the country. Now the government is going to try to
develop its technologically challenging oil fields alone, and mark
my words it will fail.
On April 16, 2012, Argentine President Cristina Kirchner said
her government would seek approval from Congress to take a 51%
government stake in the YPF (
), the largest oil producer in the country. Until that
announcement, YPF was majority-controlled by Spanish firm Repsol
(REPYF.PK), which just months ago announced the discovery of almost
a billion barrels of recoverable resources in the Vaca Muerta
("Dead Cow") formation in Argentina's Neuquen province. The
nationalization of YPF is very unfortunate for Repsol, which has
seen its share price decline dramatically since the announcement,
but it is just as unfortunate for all the Argentinians who will not
see any oil revenues now that Kirchner has turned the "Dead Cow"
into "dead shale."
YPF may be the first casualty in Kirchner's oil and gas
nationalization spree but it will not be the last, as there is
widespread enthusiasm within Argentina for further expropriation
and nationalization within the sector. Today's enthusiasm will
become tomorrow's disappointment as Argentinians taste the bitter
reality that government resource nationalization almost always ends
Kirchner is nationalizing Argentina's oil sector directly, but
lots of resource nationalization is done in much more roundabout
ways. These devious methods include: increasing the tax levied on
oil production (United Kingdom); introducing a windfall tax
(Ecuador); or suddenly adding capital-gains tax to sales of oil
projects (Uganda). In all these cases, the governments wound up
with more money while the oil companies and their investors got
stuck with the bill. "Big bad oil companies" are frequently made
the bogeyman, but in reality profit margins for oil production keep
getting slimmer and slimmer - and the real bogeyman is often a
Whether a government is direct or covert about its desire to
nationalize its resources, the results are the same for global
resource explorer-developers: increased risk. It doesn't take long
before the risk-reward balance becomes skewed toward risk and
companies begin to pack up and leave.
Guess where that leads? To lower production volumes and higher
Reason 5: "Shale Revolution" - A Purely North-American
Porter argues that a global shale oil revolution could push
production volumes way up and prices way down, but this argument
assumes the world has the infrastructure to power such a
revolution. That is simply wrong.
It is not easy to drill an economic shale well, whether for oil
or gas. To get the most out of a shale formation, an operator often
needs to use a high-power - over 25,000 horsepower - frac drill
set. He has to drill horizontally, which is far more technical and
challenging than drilling vertically, and then has to complete
multiple fracs to get the well flowing.
North America has more energy infrastructure than anywhere else
in the world, resulting from years of conventional oil and gas
development and production. In North America it is relatively easy
to find drilling companies armed with these high-power frac sets,
but such is definitely not the case in most other parts of the
world. Europe, for example, is home to fewer than one-tenth the
number of drilling and fracking sets as there are in North America.
That means any shale revolution in Europe would take a very long
time to develop -the equipment and expertise just aren't there.
Yes, shale gas production ramped up quickly in North America,
but we had the infrastructure in place and just needed to adapt it
to a new kind of geology. The head start means North America is now
more than a decade ahead in a sector that Europe has just begun to
understand, and one that Russia still refuses to believe.
It is safe to say that it will take a very long time for the
shale revolution to have a major impact in Europe and elsewhere. In
the best-case scenario, we believe Europe will only have a small
amount of shale production of any type twelve months from now.
Reason 6: The Easy Oil Is Gone and Shale Oil Wells
Decline in a Big Way
The IEA estimates it costs between $4 and $6 to produce each
barrel of oil from the conventional fields in Saudi Arabia and
Iraq, including capital expenditures. Algerian, Iranian, Libyan,
and Qatari fields cost slightly more, at about $10 to $15 per
barrel. These countries produce most of their oil from relatively
easy, straightforward, conventional deposits.
My perspective on energy resources revolves around the fact that
there are no more of these big, easy deposits to be found. The
deposits of tomorrow are harder to find and more complicated,
expensive, and risky to develop. Companies now have to manage the
litany of challenges inherent in getting oil out of places like the
oil sands, sub-salt deposits, and ultra-deep offshore
With increased difficulty comes higher production costs. This
also means that if oil prices fall too low, costs will overwhelm
revenues and production will shut down altogether.
The Canadian oil sands are a perfect example. Producing projects
in the oil sands need an oil price of at least $60 per barrel to
remain economic - and that assumes capital costs have already been
repaid. To build a
oil sands project, a producer needs to believe prices will remain
high enough to cover not only his basic production costs but also
to repay his huge capital outlay. As such, new oil sands projects
are uneconomic to develop without an oil price of at least $85 per
The oil sands are by no means the only important oil region with
high production costs. To access most of the world's unconventional
oil resources, companies need to drill
, which costs much more than drilling vertically. After drilling
horizontally, producers have to frac the well in many stages to
achieve commercial production. This means each well costs many
million dollars, an expenditure that is not going to be economic at
What is more, these wells decline much more rapidly than
conventional wells. Production from any well falls with each
passing year, but with unconventional wells the decline can be
dramatic. In fact, shale wells typically decline by more than 50%
after their very first year. To maintain production, companies need
to be constantly drilling and commissioning wells, a treadmill
process that increases the production costs significantly.
In the world of unconventional production, companies are faced
with a double whammy: they need to drill more wells than a
conventional field would require; and each well is much more
expensive. Companies are not going to bother with this challenge if
low prices make it a money-losing endeavor. Once production begins
to shut down, the world will panic and the price of oil will turn
upward once again.
Reason 7: The World Is Always Hungry for Oil - and Oil
The world is not awash in oil. On the contrary - we produce only
just enough oil to meet global demand. With the world's population
growing every day demand continues to rise, making the balance ever
tighter. Even the threat of major production cuts of the sort we
just discussed - which would surface the moment the oil price fell
to $85 per barrel - would be enough to send tremors through the
global oil machine and push the price of oil back up.
It is not only traders who will react to push prices back up.
Countries will jump at the chance to secure oil supplies on the
cheap. You see, for the oil-needy nations of the world, having to
constantly walk this supply-demand tightrope is far from ideal. Far
preferable would be to control of enough oil deposits, at home and
around the world, to meet national needs. With nation after nation
coming to this realization, the race is on to secure energy
China is the biggest player in this arena. Armed with a massive
bank account, the Chinese are seizing every chance they get to buy
major deposits. If the price of oil starts to slide, as Porter
suggests it will, the value of major oil projects will decline as
well and the Chinese will act, buying up any reduced-price oil
deposit they can find. Acquisition activity like that will push
prices back up again, if for no reason other than that people will
remember the finite and declining nature of our world's oil
I also think the starting gun has already gone off in the global
race for uranium, but that's a story for another day.
Reason 8: A Falling Oil Price Means Big Chunks of Global
If exploration drills find an oil deposit, data from those
drills are used to calculate a "resource estimate," which is a
geologic best-guess of how much oil the formation holds. However,
oil in the ground is not necessarily oil that will ever see the
light of day. That's where the "reserve estimate" comes in.
Reserves are an estimate of the amount of oil within a deposit that
can be extracted economically.
Let's look at both of those words: "extracted" and
"economically." Whether oil from a deposit can be extracted depends
on the geologic parameters of the deposit and the technical
abilities of today, which combine to determine how much of the
deposit is "technically recoverable." Then the "economically" part
of the description comes into play. Oil is only "economically
recoverable" if the cost of production is less than the price of
oil - put simply, the producer has to be able to make a profit.
Remember, my outlook on energy resources is based on the premise
that most of the easy deposits are gone. In general, only the
hard-to-find and expensive-and-complicated-to-produce deposits
remain. Producers cannot make money from these challenging deposits
if oil is cheap, which means reserves will revert to being
Examples abound. It costs far more to produce a barrel of oil
from the deepwater Gulf of Mexico, Canada's oil sands, Russia's
Arctic waters, Estonia's oil shales, or Brazil's deepwater sub-salt
deposits than from the big, conventional oil fields of yesterday,
like those in Texas or Saudi Arabia. Oil reserves in these places
will evaporate if oil prices fall and render them uneconomic to
develop. The world's oil resource count will remain the same, but
resources are useless if we can't get them out of the ground.
The world uses a lot of oil. All of that oil has to come from
our finite pool of oil reserves. A falling oil price would
gradually eliminate that pool, because the cheap oil is gone. And
that simply doesn't stand up to supply-demand logic.
Reason 9: Between the Lines - By-products
One reason that North-American gas producers continue to drill
select wells is because certain shale reservoirs contain lots of
Natural Gas Liquids ((
)). These liquids, comprised of bigger carbon molecules than the
methane that is natural gas, trade at a significant premium to
natural gas. Furthermore, these NGL-rich natural gas wells often
also produce some oil.
The presence of these bonus products means producers in NGL-rich
areas can continue to operate because revenues from the sales of
by-product NGLs and oil compensate for rock-bottom natural gas
prices. The result is upside-down - for these operators natural gas
is still the primary product by volume but is the least-important
product by value - and ironic, because by continuing to add to the
natural-gas supply glut in North America their gas output is
actually perpetuating the gas pricing problem. But the point is
that the price of gas doesn't matter: as long as the NGLs and oil
continue to flow out of these wells, the operator will remain
A similar paradigm does not exist in an oil well with natural
gas as a by-product, because of course gas is worth far less than
oil. If the price of oil began to fall dramatically, companies
would simply stop drilling and there would be no upside-down
by-product incentive to continue.
Reason 10: Black-Swan Events - The Fragile Supply-Demand
A "black-swan" event is a rare but highly significant event with
dramatic impact. The collapse of Lehman Brothers, the Arab Spring,
and the Fukushima nuclear disaster are all examples of black-swan
These events tend to tilt more in favor of a rising oil price.
Consider this: the loss of oil production from Libya - which
represented just a small fraction of the world's production -
caused the price of oil to move 25% in just two months.
As we have mentioned before, the world produces barely enough to
satisfy global demand at the moment. That is precisely why any
significant impact on the supply side generally shocks the market
And there are a good number of possibilities that could quite
easily occur that would send the price of oil much higher: a war
with Iran; OPEC reducing production levels; terrorist attacks in
Nigeria; renewed social unrest in the Middle East … the list goes
on. The point is: if something goes wrong geopolitically in the
world, it is more likely than not that oil will begin shooting
And there you have it - ten reasons why the price of oil will
not hit $40 a barrel in the next 12 months.
Porter, I respect your opinions and consider you a friend but,
just like I took your money in our poker game, I look forward to
laying my hands on your 100 ounces of silver, should you accept my
[Porter gave his shocking analysis of the oil market at the
Casey Research Recovery Reality Check Summit
in Florida last weekend. It was one of a host of eye-opening
presentations attendees heard over three days from 31 financial
luminaries, including former director of the U.S. Office of Budget
and Management David Stockton, famous contrarian investor Doug
Casey, and resource investing legend Rick Rule. And even if you
weren't able to attend, you can hear every recorded presentation
and every piece of actionable investment advice in the
Summit Audio Recordings
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
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