You’re telling me you can’t borrow another 100 grand to help you
pay the fuel bill? Or cut 100 grand worth of other costs so you save money to buy shares in an oil company?
As you know, at just over $40 a barrel (January 22) the price of oil was down over 100 bucks from its peak last summer. But the price isn’t likely to stay down too long. Several things are working in the background that will sooner than later drive up the price of oil again.
Last time the price of oil went up, most of us got caught more or less off guard. This time around we should get to understand what is going on and then do what we can and or have to do to guard ourselves against the higher prices. Some of us will actually make money as we deal with higher oil prices and maybe you can, too.
I will explain how I see the oil market and give you several ways that might help you deal with the next jump in the price of oil.
Four things are working in the background that will drive up the price of oil in a matter of time.
Wells Pump Less Oil
First of all, most wells produce about 15 per cent less oil now than they did a year ago. The industry offsets that by drilling 15 to 20 per cent new replacement wells each year.
The oil industry produces around 86 million barrels of oil a day. It could produce maybe 88 or 89 million but the world doesn’t need that much oil so why bother. Consumption was around 86.5 million barrels per day, but as the price of oil went up and the economies came down, people started to drive less, bought cars that use less gas, and consumption dropped.
So some estimate that the world now uses about 81 million barrels per day, 5.7 per cent less than a year ago. A year from now, most wells will produce less oil than now, and as the price of oil dropped fewer new wells are being drilled.
Opec Pumps Less
Countries in OPEC like expensive oil. It gives governments in Venezuela, Iran, Russia and elsewhere money to buy votes and friends in high places. Seventydollar oil can buy a lot more than $40 oil. So OPEC has cut production to raise the price. But from what I hear, when OPEC announces a goal, it is only 88 fulfilled. When it announces cuts of 4.2 million barrels per day (mbpd), for example, it might cut only 3.6 mbpd. That drops supply from the old 86.5 mbpd to 82 to 83 mbpd. So there’s still a little extra oil around.
Store Oil On Ships
Some of that extra oil is being stored on ships. It costs about $1.60 a barrel to store oil on a big boat for a year. But as I write in early January, the price of oil is near $40 but a person or business that owns oil could sell that oil on the futures market for delivery in January 2010 and get $50 a barrel. Subtract $1.60 and there’s $8.40 of profit.
So I can see why and how individuals and countries could reduce the supply of oil to the market by loading it on a ship and selling it for delivery a year in the future.
More Oil Will Be Used
In Venezuela, gas is something like four cents a liter. It’s cheap in Iran. It’s subsidized in China. And more people are driving in all of those countries. Sure Americans are driving less now, but give them a few months.
Americans, in total, save $1 billion for each one cent the price of gasoline drops. Even now, with unemployment at seven per cent, it means 93 per cent are still working. The average American has 1.7 jobs so even though unemployment is getting close to seven per cent, it doesn’t mean seven per cent of Americans are broke and destitute. Some work under the table, some just work more at their other job, some have paid down debt, and the cost of interest on mortgages is dropping and the cost of gasoline is way down.
It all adds up to Americans having more money than they had just months ago. Plus most people have a low threshold for saving. It won’t take long and they will have paid down some debt, they will have saved up a few bucks, the credit cards will get paid down or get paid up. I believe “we should stop being so tight fisted” will become a phrase sooner than most people think.
The one thing that will hold some back from spending more is that their retirement/savings accounts have been cut by 40 per cent or so. Again it’s only a matter of time and many will figure out that they can’t “save” their way back to 100 per cent of those accounts. It won’t take long and they will get used to the idea that they might have to work longer, and save a bit more, but sooner or later most will return to their old spending habits. And they will have more money for the reasons I have outlined.
It all adds up to rising oil prices. It’s just a matter of time.
What To Do About Higher Oil Prices
You and maybe a group of farmers could try to rent a boat and buy a million barrels of oil and store it for a year and make 15 to 25 per cent on your money. One reader of StocksTalk wondered why KAP and other farm organizations weren’t out there looking for ways to help farmers buy and store cheap diesel fuel. I don’t hear boo about that idea.
Storing diesel isn’t as easy as one might think. Today’s fuel has no sulphur so it can spoil sooner than the old stuff. Then if you buy fuel before March you’ll get winter fuel, P20, which produces less power than the P40 you use in the summer. And if you store summer fuel, you won’t be able to use it in the winter. Plus there is the threat of someone stealing the fuel and so on and so on.
Perhaps the easiest way to offset the inevitable rise in the price of oil is to buy some good oil stocks and sell covered calls on them. We own Imperial Oil (IMO) and PetroBank (PBG). As I write, options on IMO pay us $1.50 on a $41 stocks or so per month and PBG pays us 75 cents on a $21 price. That’s about 3.6 per cent per month. On $100,000 worth of shares, that could bring in $30,000 to $40,000 a year. For most farmers that would offset a lot of the higher fuel bills that might be around the corner.
“We don’t have $100,000 to buy shares in Imperial Oil.” I can hear readers all over the country say those words out loud as they wonder what I’m smoking. Well, just a minute. Most farmers likely are going to borrow anywhere from $100,000 to a couple million bucks to buy fertilizer, seed AND fuel to put in a crop. All of that money will be spent on irreversible decisions. The money will be gone. Burned or shoved in the ground. And you’re telling me you can’t borrow another 100 grand to help you pay the fuel bill? Or cut 100 grand worth of other costs so you have money to buy shares in an oil company?
Are you saying that seeding a crop with no guarantee of prices or good weather is less risky than buying shares in an oil company when we are pretty sure the price of oil is going to go up?
“I don’t know what to do” is another common sentence. That’s likely true and you’ll be hard-pressed to find someone who can help you learn, so you might as well subscribe to my newsletter StocksTalk and read it and learn this skill. Remember: Once you learn this stuff you’ll be able to use this skill as long as you farm and for years to come.
I don’t want to be too hard on farmers and readers of Grainews. But I do have a question: When will you start to take responsibility for your own financial future and learn and do what you have to do to control your economic situation? My goodness, Imperial
Oil stocks were around when I was learning to walk. And someone says it’s a risky stock? The other day a fellow said he lost some money in stocks so he’s been out of the market for 15 years. I asked him if he had a crop failure or a calf die, would he wait 15 years to seed the next crop or let the bull out with the cows.
So stocks are risky compared to what? Compared to seeding a crop with all of its irreversible decisions? Or owning beef cows? And if you don’t like IMO, buy Husky Oil (HSE) and do the same thing. I don’t mean to be a smart ass or mean but gosh, this education is staring you in the face and you’re ready to borrow money or spend your own for all kinds of other expenses, but not to buy an asset and learn how to make it pay for your fuel bill. Again I don’t want to be mean, but many people spend their whole life on a business or job or whatever that ends up with very little payback but they don’t want to spend a couple hours a week learning how to make money with stocks…a skill that can work for them pretty well until they die.
And I don’t see your farm organizations or the universities offering to help you learn how to manage stocks or sell covered calls. The farm organizations seem to be ready and willing to beg governments for money but not to help farmers become more self sufficient. Some would say that’s the way it should be. And universities….well. Most professors don’t know this stuff so I guess we can’t blame them. And if farmers don’t stand up at meetings or at courses and ask for this education, it will never be there for you and your children. So you might as well start learning it yourself.
By the way money you get from selling covered calls is taxed as capital gain, so only half of it is taxable while you get to deduct the whole cost of the fuel you buy.
Well, enough of my ranting. The price of oil is bound to go up. You now have a choice. Learn how to make extra money to offset those higher prices or PAY them.
Andy lives in Winnipeg. He manages his own stocks and sells a lot of covered calls. He also publishes a newsletter called StocksTalk where he explains what he does in great detail. If you want a subscription free for a month send an email to [email protected]