Thursday, October 22, 2009

More On Oil

I knew some of my oil friends would email me about my oil post. I got several. Below is one from a friend who works directly in the oil industry. He brings up a good point. How do you protect yourself against $150 oil from an investor standpoint. Simple. You don't short oil. Two things you should never short and that is oil and gold because without warning something could happen to cause to price to skyrocket in a blink of an eye. I don't have problems shorting oil or gold companies. One, you can be shorting operations. Even if the price skyrockets, operational failure can do a company under. Also, a big problem in the middle east can cause the spot price to skyrocket but way out on the futures curve to move up only slightly. As a result, if your short a front month oil contract you can lose a fortune but a company will move up much less because the cash flows 3 years out will normalize (plus alot of oil companies won't even benefit from a short term spike because they have hedged the price they are selling at in the short term).

From a friend:

Thought your opinion of oil was right on. for actual valuation purposes.

You are also correct in understanding that traders and investors try to build in a protection mechanism against disruptions in the middle east and elsewhere. Also noteworthy is the fact that our Secretary of Energy is against EP activity and for Nuclear energy. So, Cap and Trade- type bills could send the prices of energy higher.

And you are also correct in understanding that, with newer technology, we are drilling wells that deplete faster. Which means more current supply but less promise of future supply. And that means that we have to continue producing and exploring.

At any rate, as you mentioned, we are overvalued right now. I would place us at around 50 dollars a barrel. I moved out of oil stocks (something I understand) at 70 and planned to trade a trading range of 50-70. However, I did not see a digression and fortunately did not buy puts at 70/bbl.

If you watch start up EP firms carefully, you can catch discrepancies between the price per crude and the price per share of stock. And if you know shares outstanding and the firms' production levels/reserves/leases ... you can estimate value and buy or sell accordingly.

But I think we need to see the bubble seep some of the hot air that is inside of it. However, if a middle eastern country does something we do not like ... we could be at 150 in a heart beat. How do you protect against that from your viewpoint?

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