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'There Are No Easy Barrels Left'

By Matt Badiali, editor, S&A Resource Report
Thursday, October 11, 2007

I'd never heard the world's crude oil situation explained so simply before.

But that's how J. Robinson West, of PFC Energy, a consulting firm in Washington, sums it up. I've read literally thousands of pages on the energy markets, but West's comment in the New York Times cuts to the chase with just six words:

"There are no easy barrels left." 

You see, from the late 19th to mid-20th century, finding oil was more luck than skill. Easy discoveries launched the golden age of oil discovery in Pennsylvania and Alberta, Canada. Those early discoveries often had clues, like oil seeping into local rivers. 

As demand increased, some savvy geologist in Texas realized that rocks warped into inverted bowls (called anticlines) might hold oil. The discovery at Spindletop sent drill rigs onto every anticline and eventually any other structure that could hold oil. 

Things are a lot different now. 

We shoot sound waves thousands of feet through water and rock, then process the wiggles into useful data. We use geochemical "sniffers" to detect the merest whiff of oil or gas. Sometimes we take a theory, back it by millions of dollars, and get lucky.

That was the case with deepwater oil in the Gulf of Mexico. What we learned there spread throughout the world. Now deepwater is the best place to find a giant oil field.

Deepwater costs escalated the most out of all the oil sectors over the last seven years. According to Oil and Gas Investor, deeper-water projects have experienced the largest cost increases.

Service companies that operate in deep water can practically name their price. Rig rates for the big, deepwater-capable anchor handling, towing, and supply vessels increased by 70% since the first quarter of 2006. And the latest data shows that those rates jumped 10% from the first quarter to the second quarter of this year.

Companies interested in deepwater drilling responded to rising costs by increasing their capital budgets. Chevron's 2007 capital budget increased 25%. Petrobras did the same by 32%. The companies are ready to spend. S&A Oil Report readers have rode this spending boom to a 49% gain in just six months with CGG-Veritas, the global leader in seismic mapping.

In fact, I expect spending on finding and development in 2007 will exceed expectations. Analysts used $57-per-barrel oil to estimate how much money companies would be willing to spend. They underestimated both the price of oil and the level of investment.

The average spot price for the crude oil benchmark West Texas Intermediate (WTI) over the last year was $65 per barrel. In fact, the average WTI price for the last two years was... $65 per barrel.

Guess what I think the new oil price is likely to be going forward...

As the industry begins to accept the new reality of $65-a-barrel oil, all kinds of new areas will open up to exploration. The first beneficiary of this new reality will be the deepwater sector. I consider deepwater oil drilling the new frontier for oil exploration. I encourage you to become familiar with the companies that profit from this trend.

Good investing,

Matt Badiali

Market Notes


Bloomberg provides our latest update from Hong Kong: "Taxes on salaries will be cut to 15 percent and on company profits to 16.5 percent in the financial year ending March 2009, Chief Executive Donald Tsang said in his annual policy address today."

In other words, Hong Kong wants to keep the No. 1 spot on the Economic Freedom Index, the global barometer of how easy it is to do business in a country. The financial hub ranks just ahead of Singapore and Ireland on how pleasant business owners find the laws there. Heck, they even call the guy in charge "Chief Executive."

Given its excellent business environment and dominance as an Asian financial center, it's no wonder the Hong Kong ETF has nearly doubled in the past two years... and it's no wonder Sjuggerud Confidential subscribers are up more than 70% on Hong Kong holding company Cheung Kong.

As U.S. residents, we'd love to see Washington adopt Hong Kong's low-tax policies. It would produce one of the greatest economic booms in history. However, we aren't holding our breath.

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