Jim Jubak

Jubak's Journal8/26/2008 12:01 AM ET

To mix oil and profits, think small

The big Western oil companies are stuck in an exploration lockout and won't lead crude's inevitable climb. For that, Petrobras and 8 other lesser-knowns are better bets.

By Jim Jubak

There's a crisis in the oil industry -- at least among the publicly traded oil companies of the United States and Western Europe. Falling oil prices aren't the cause of this crisis. And rallying oil prices aren't going to fix it.

I think this summer's correction in oil prices is just a pause in the long-term upward trend. I stand by my April prediction that oil will hit $180 a barrel by April 2010.

But higher prices won't solve the production problems facing the big international oil companies. The stocks that most investors think of when they think of investing in oil -- and the oil stocks that make up the biggest share of energy exchange-traded funds and mutual funds -- aren't going to be the best performers in the sector over the next decade.

I think you'd do much better owning a mix of the shares of more-obscure and smaller oil producers, the shares of a few publicly traded national oil companies and the shares of oil drilling and service companies.

In this column I'll explain why I think investments in those shares will outperform money plunked into the shares of the Western majors; I’ll also give you some stocks to consider for your portfolio.

The crisis facing the major Western oil producers isn't the result of the 22% drop in the price of a barrel of crude from the intraday high of $147.27 on July 11 to the Aug. 19 close at $114.53. That Aug. 19 close was, after all, still a huge 59% above the August 2007 spot price of crude, according to the U.S. Energy Information Administration.

So, no, the publicly traded international oil majors -- ExxonMobil (XOM, news, msgs), BP (BP, news, msgs), Royal Dutch Shell (RDS.A, news, msgs), Chevron (CVX, news, msgs) and the like -- aren't facing a crisis because oil was selling for just $114.53 a barrel.

The big oil companies are in crisis because their production is falling. You'd figure that with oil at $114 or $147 or even last August's $72 a barrel, the big companies would be doing everything they could to pump more oil to boost profits. And that they'd be doing everything they could to find more oil and to get the new discoveries into production.

But that's exactly what isn't happening. For the second quarter of 2008, the five biggest publicly traded oil companies -- ExxonMobil, BP, Royal Dutch Shell, Chevron and ConocoPhillips (COP, news, msgs) -- reported earnings of $44 billion and a decline in oil production of 614,000 barrels a day. The decline marked the Western majors' fifth consecutive quarterly drop in oil production.

During the same period, the oil producers that make up the Organization of Petroleum Exporting Countries have been able to jack up production to an estimated 32.6 million barrels a day in July, an increase of 2 million barrels a day, or about 7%, since June 2007. That increase in supply plus a drop in demand in the U.S. and Europe due to higher prices and slower economic growth led to this summer's retreat from the July high. (OPEC now seems to be in the process of unwinding that increase in order to prevent oil prices from falling much further.)

Crude realities

In the long term, though, almost nothing has changed. Growth in the demand for oil still threatens to outstrip growth in supply. In June, oil consumption in China topped 8 million barrels a day for the first time, and the International Energy Agency projects demand from China will grow 5.6% in 2008 and 5.7% in 2009. Demand will more than double, to 16.5 million barrels a day, by 2030, the agency says.

India is seeing an even bigger jump in its demand, which is projected to grow 8% to 10% in 2008. And because India imports 76% of its crude, at these rates of demand growth, India is projected to become the biggest oil importer in the world by 2025, according to the energy agency.

You'd think these projections would have sent the Exxons, the Chevrons and the BPs of the global oil industry into a frenzy of spending on exploration in an effort to find new oil. But that isn't what the numbers show. The amount spent by the 25 largest international oil companies on exploration did in fact increase, to $28 billion in 2007 from $13 billion in 1994. But almost all of that increase was eaten up by the soaring costs of everything from drilling rigs to steel pipe to engineers' salaries, according to SEB Enskilda, the investment banking arm of the SEB Group.

Continued: Oil exploration

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