Is Energy The Next Big Investment?
Over the last two years the oil price fell more than 70% (measured in US$). The downturn was both epic and brutal. The victims are now starting to emerge and it is not going to be pretty.
Many of the shale producers in the US are drowning in debt and not profitable at the current oil price. I’m expecting quite a few of them to go belly up over the next year or two. Saudi Arabia suffered a record budget deficit of US$ 97.9 billion for 2015 and was forced to dip into their foreign reserves to make up for the shortfall.
The seasoned investor holds dear the motto: buy low, sell high. In that light, is energy the next big investment?
In my opinion: yes.
But not yet.
How low can it go?
On the supply side, who knows what is going to happen?
Iran just announced a few days ago that they will increase oil production by 500,000 barrels a day (according to their deputy oil minister).
Despite their current record deficits, the House of Saud has a significant amount of foreign reserves and can afford keep supplying oil in quantity for quite a while. They may just choose to do that, sacrificing short term pain in exchange for long-term market share and the opportunity to squash their less resilient competitors, of which there are quite a few.
At the same time, a lot of those less resilient competitors may start closing up shop, not to open up again until energy prices rise sufficiently to make the juice worth the squeeze. I’m quite confident that the next investors in these areas will also be a lot more cautious before they start producing, now that they know just how quickly the tide can turn.
Worldwide economic depression?
As far as the oil price is concerned, it is on the demand side that I see the real trouble brewing.
As I’m sure my regular readers are well aware of by now, I’m of the opinion that the world is entering a global economic depression, possibly of a magnitude worse than we’ve ever seen before.
Banks are levered 40-to-1, debt-to-GDP ratios are through the roof, the poor remains poor, the middle class is ready to tap out, and the 1% can only buy so many houses, yachts and Ferraris before they start having trouble figuring out which key belongs to what.
The global economy got addicted to debt, had a massive party while the going was good, and ended up overdosing. It is currently receiving CPR in the casualty ward. The CPR is frantically being administered by a bunch of desperate doctors, ironically the same ones who prescribed all the debt to the patient in the first place.
When the global economy wakes up again, it is going to wake up in rehab.
I’m of the opinion that there is going to be a lot less manufacturing, transporting and consuming happening in the next few years.
I won’t be at all surprised to see oil prices fall further.
A world addicted to oil meets a falling EROI
I just explained why I believe the world’s addiction to debt has driven the global economy into a depression. What I haven’t mentioned yet is that the world has another addiction too: fossil fuels.
And fossil fuels are running out.
EROI, or Energy Return On Investment, is the amount of energy you can produce, divided by the amount of energy you need in the production process.
The best way to think of EROI is to ask a question like this: given one barrel of oil to use as energy, how many barrels of oil can we produce?
In the early 1900s, it was possible to produce more than 1000 barrels of oil, using only 1 barrel of oil’s worth of energy.
Unfortunately, the vast majority of those easy-to-extract energy sources have been depleted long ago and the EROIs associated with production are becoming exponentially worse.
Nowadays, a really good find will have an EROI of perhaps 40:1 (produce 40 barrels of oil for every 1 barrel’s worth of energy invested) and, on average, an EROI of perhaps 20:1.
A world full of addicts addicted to a drug that is running out… now there is a recipe for significantly higher prices.
When the bust is almost over and the next boom is about to commence, I’ll be looking very carefully at the energy sector as a place to invest.
An investment into the energy sector worth making right now
There is one investment into the energy sector that I do think is worth making right away: reduce your own dependence on energy.
You can make a great investment right now by learning to live a simpler and less complex life, and investing in infrastructure now that will allow you to use less energy in the future.
If you can break your own addiction to an abundant source of cheap energy, you will be much better prepared, both mentally and financially, for the inevitable rise in future energy costs.
Preparing early will not only help you to face the challenges presented by a world with drastically more expensive energy, it will also make it possible for you to take advantage of the opportunities that will arise because of it.
A note of thanks
I would like to thank the following people for their excellent work on this subject:
- Chris Martenson and the folks over at PeakProsperity.com. For an excellent and thorough overview of the three E’s (the economy, energy and the environment), please check out The Crash Course.
- Steve St. Angelo from the SRSrocco Report.