“Making predictions is hard…especially about the future”; one of my favourite expression from the late Yogi Berra.

Today is one such day.   As I’ve indicated to a great many clients recently, opportunity is at hand.  Borrowing further from baseball Lexicon; the key to hitting one out of the park, is to wait for the “fat pitch”, and as you read this, a fat pitch might be metaphorically approaching us from the mound, (or in this case, from next Tuesday’s OPEC meeting in Vienna).

A brief, and Current History of Oil, (some context);

Back in March of 2014 I read an article about the diminishing global oil storage capacity. Oil was so plentiful that countries and companies were resorting to storing oil in giant subterranean salt cavern and ocean-going oil tankers sitting off shore as the world’s storage tanks were within eight months of reaching full capacity. Oil demand was about 95 million barrels/day, supply about 96.5 million barrels/day and growing – there was no place to put the stuff!

At that point it was common knowledge that the Saudis were increasing the production of oil to “buy back market share” lost to the Russians and the US wildcat drillers. Back then hundreds of US companies were opening up previously unrecoverable reserves under the continental plains that run from North Dakota to Texas with new fracking technology and had been able to double US domestic oil production. In a few short years the US had gone from being a net importer to a net exporter of oil.

US Laws enacted during the 1973’ Oil Crisis, were changed in 2015 to enable companies to hold crude oil, (unrefined) in the hulls of ships anchored in US harbours. It was previously illegal to “export unrefined oil”; holding oil in a ship’s hull at port was deemed an export and hence illegal.

Until 2014, the Saudis, having the lowest cost oil reserves in the world, operated as the swing producer to the world. By changing oil production rates they could and did moderate and maintain the high price of oil.  In early 2014 they abandoned this responsibility and effectively rendered the OPEC Oil Cartel toothless. Albertans watched in awe as the price fell from $114 to $27 US by Feb 2016.

To use another famous Yogi Berra quote, “it was deja vu… all over again” – at least for the Albertans. Many of us remember Alberta house prices plummeting in the 80’s.  Alberta oil, aside from being discounted due to its thick and high sulfur content, had the added problem of inaccessibility to global markets– they are a land-locked producer of a global commodity.  By 2014, TransCanada Pipeline had spent six years petitioning the US for permission to build a trans-border portion of a pipeline connecting Canadian production to the refining hub of North America in Cushing Oklahoma.  Understandably, the last thing the US needed was more oil, so the permission was delayed and in 2015 finally denied by Obama’s Presidential Veto. The Canadian response was to transport more oil by train – a more costly and environmentally riskier option.

The Russians, on the other hand, though not part of OPEC, produced 10% of global oil, were impugned with countervailing trade embargos and had assets frozen by the West for invading the Crimean and covertly intervening in the Ukraine. Since wealth and trade are inseparably linked, Russia responded by increasing oil production and exports in exchange for foreign currency and goods, thereby mitigating financial hardship and political instability at home, further compounding the glut….

Turn forward the pages to next Tuesday, (Nov 30^th), when OPEC has scheduled a meeting to fine-tune the logistics of which countries will limit production and by how much.  Furthermore, news media has reported that Russians are onside and will add to production limits, (though this could prove to be false).

The Opportunity:

Oil prices are at $48/bbl today. Thursday, Friday and Monday are US holidays. If an agreement is reached between all parties on Tuesday, supply and demand will reach equilibrium and oil prices will increase.  Oil companies have spent the last year reducing staff, cutting capital investment, and parring their dividends.  The best companies are profitable at $30/bbl. Indications are that Trump will overturn Obama’s pipeline Veto within the 1^st semester (24 months), further lowering Canadian production cost and increasing accessibility. Oil could find a new equilibrium between $60 and $70/bbl in the next 24 months, increasing Canadian company profits and increasing dividends. One thing is for sure – it’s gonna be interesting to watch.

The Risk:

If no agreements are reached, the equilibrium date would be pushed back.  Prices of oil and oil stocks will soften in the short run, possibly by as much as 20%.  This strategy is not for those with a low tolerance to risk or those with a short time horizon.

There are two prevailing facts that minimizes the downside to a “no agreement” outcome;

1)      Global oil demand is growing at 1 million bbl/day, (approx 1% of 95 million bbl/day). So in one year’s time, (or less) demand will meet supply anyway, and prices will start to rise. Although there is a growing economy for renewable energy, the demand for oil according to the International Energy Agency, will increase by 25% by the year 2040.  The world is not done with oil!

2)      There is a 4 to 5 % natural yearly drop-off or attrition in oil production from existing wells. Production rates falls naturally without doing anything.  This is best illustrated with a milkshake metaphor; when you get down to the bottom of a milk-shake you have to move the straw around through the ice residue to get that last bit of shake. Similarly, in the oil business every hole has to be moved and re-drilled in order to maintain a given flow rate. Just to stay at the current production capacity, companies have to re-invest capital and labour.  When oil prices are low and profits non-existing, there is no capital to maintain the existing production, and workers are laid off, which is a supply diminishing factor in the industry  – this reminds me of the saying, “the cure for low prices are low prices”.

So, where do we go from here?

This is where you come in; if you’d like me to shift some of your portfolio to take advantage of this, I’ll need an email from you, I need a paper trail of our conversation. I recommend and allocation of between 5 and 10% of the Canoe Financial Energy Class fund. Although not without its bumps and gyrations, it is the best in its class (5 star Morningstar rating). It is run out of Calgary by Rafi Tahmazian with a deep understanding of the energy business and a frequent face on BNN. It comes in an F series which is low cost, service fees are transparent, and you can transfer into and out of the fund at no cost, (many of you have owned this funds in the past). As a hedge, the fund is diversified and has a small but growing investment in renewable energy companies.  Here is a link to fact sheet on the fund. http://www.canoefinancial.com/assets/pdfs/Energy_Class_F.pdf