Peak Oil: It's No Myth
If you've been following the oil industry for more than a few years, you are familiar with the concept of “peak oil.”
And if you aren't, don't worry, because it takes about 10 seconds to explain and no time at all to understand.
Here it is, in a nutshell:
The total world supply of fossil fuel is finite.
Every year, we burn more of it.
Eventually, there will come a point where demand will exceed production capacity.
The reason peak oil became a buzz-phrase over the last couple years was because some believed we had already reached that point — the point where global production has maxed out, causing an inevitable escalation in prices as more and more people compete for fewer and fewer resources.
You see, oil prices were shooting up in the first decade of the 21st century — more than quintupling from $25 per barrel in 2000 to around $140 per barrel in early 2008.
It made millionaires out of amateur investors and billionaires out of industry pros.
It also gave peak oil theorists more than enough time and evidence to convince people it was happening — and more evidence really wasn't needed. We were all feeling it at the pump at the time, as we saw prices rising on an almost hourly basis.
But It's Also Still Not Reality
Unfortunately for the theorists — and fortunately for the rest of us — peak oil hadn't arrived just yet.
Not only did prices crash during the financial crisis, as demand dried up and the fracking revolution kicked North American production back into gear, but they rose only to crash again in 2014 to half of the four-year average.
Just as they did during post-2008 peaks, investors panicked as their oil-heavy portfolios lost years' worth of gains in weeks.
Another set of investors, however, got ready to take advantage of the opportunity.
And here's where peak oil comes back into the picture...
You see, although they may have been wrong about peak oil striking in the early 2000s, they are absolutely right that it will come eventually.
The newly tapped deposits in North America — primarily driven by a redoubled focus on hydraulic fracturing — demonstrated that while traditional oil may have peaked, the resource may get a second wind from previously unknown or unexploited origins.
Or is it?
But these deposits won't stave off peak oil forever. While total supply is still limited, demand is forever expanding.
Where does that leave us? Well, it leaves us with the premise that over a long enough time line, the trend for oil prices will always be an upward one.
Even if they dip here and there, they will continue to rise on average — even taking into account inflation — until the energy industry literally burns out its fossil fuel-based revenue streams.
For oil investors, that is indeed good news — and it's the main reason why they pick the industry to begin with. There is simply no getting around the trend.
But as prices are in a temporary trough, investors get to enjoy another basic benefit of the oil business.
While the big corporations are fairly stable and can produce oil profitably at almost any price, small ones — especially those working on new projects with never-before-tapped deposits — can only be profitable come a very specific milestone in crude pricing.
A company that's making zero money producing oil at $70/barrel would be making a pretty good margin when it hits $100 — and shareholders will feel that effect on their bottom lines the moment a company crosses from red into black.
It's really the same rule as “compound gold,” which states that the most efficient way to squeeze gains from gold or any other precious metals companies is to find those on the very edges of profitability and wait for the uptrend to send their stocks up the moment the market cooperates.
Effectively using that method, an investor can take just a couple percent gain in gold (a move of $20 to $30 per ounce) and leverage that into a 100% to 200% gain on a microcap gold producer that just went from losing money to making it.
The problem with gold or silver, though, is that it's not easy to determine what the market is going to do. Like oil, gold and silver are both finite, but they're also usually recoverable and therefore reusable.
The same cannot be said of oil.
Forget Formulas. Common Sense is Good Enough.
So how does all this play into finding the perfect microcap oil play?
Well, as oil prices remain depressed from their $100/barrel multi-year averages, we're going to be seeing a lot of smaller producers whose stock is equally depressed.
In fact, as many of these smaller companies have mingled with disaster and probably even bankruptcy, the bargains to be found on the market at these levels are plentiful.
So next time you drive by a gas station and marvel at the low prices you're seeing for a gallon of premium unleaded, think to yourself that that's just the second-best aspect of the recent downtrend.
Peak oil will come eventually, but even before it does, prices will trend higher. Once it comes and passes, that trend will only strengthen.
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