Edward: ****Off Topic****
This was emailed to me. Something to think about.
Here's an economic and industry story that would make James Grant tingle
with excitement. The setting is the fifth annual Rauscher Pierce Refsnes
Energy Conference in Houston several weeks ago.
It included about 200 securities analysts and portfolio managers, and
over 350 corporate representatives from more than 150 exploration and
production companies, oil services companies and other related
industries. There were several hundred more industry observers, media
representatives and a good number of analysts, salespeople and managers
from Rauscher Pierce. All for the sole purpose of convincing the
investment community that their company was a great investment, or a
better investment than the company that had spoken two minutes earlier.
Overall, it was the best-attended energy conference yet, and surely the
sign of a cyclical industry that has overheated and may be approaching a
top.
The first signs are evident as one flies into Houston Hobby airport and
sees an abundance of corporate jets lined up at the private hangars.
Most of these hangars haven't been filled since the early 1980s, the
last great oil boom. Driving through Houston's business districts, you
notice the unusually large number of Porsches and Ferraris. Next are the
new shopping malls or super strip centers popping up on every corner. So
much commercial real estate has been built in the last five years, it's
a mystery as to where they're going to find retailers to fill the space.
Having lived in Houston during the 1970s and 1980s, I find this is
starting to look eerily familiar.
The conference took place at one of Houston's most expensive hotels, so
expensive in fact that employees of Rauscher Pierce were put up at a
cheaper hotel down the street. The huge crowds left hardly any room to
walk down corridors between meeting rooms. Most reminiscent of the good
old days (early 1980s) was that some small-cap oil companies were not
only springing for large fancy dinners around town at Houston's best
restaurants but were also hosting open-bar cocktail parties!
Let's look at some revealing energy statistics learned at the
conference:
The North American rig count, according to Baker Hughes, stood at 1,456
on Sept. 5, more than twice the number in early 1993.
Rig utilization is at 95%, the highest in 15 years.
Industry capital expenditures are at levels not seen in recent memory.
An oil field labor shortage is leading to skyrocketing wages that far
exceed those during the last boom, according to one industry observer.
They say so much drilling is going on in the Gulf of Mexico that it's
starting to look like Lake Mead on Memorial Day weekend.
Some regional demographic notes:
Houston's three-year change in total housing units authorized was
39.4%.
Texas five-year nonfarm employment growth is 35% above the national
average.
Houston commercial and residential real estate prices are rising at
substantial rates that haven't been seen in many years. (OK, we know the
Texas economy is now very diverse with outstanding growth industries
like biotechnology and semiconductors, but let's stick to the main
topic.)
So what's going on? Average oil prices have fluctuated around $20 for
the last 10 years since coming down from their 1981 peaks (ignoring the
very short Persian Gulf War price spike). Why is there a "controlled"
boom, as the locals like to put it?
Simply because there can be. New cost-cutting technologies, more
efficient drilling methods and 3-D seismic make all this possible with
stable oil prices. The oil companies think they have it figured out this
time by "concentrating on fiscal discipline, technology, economic
returns, operating efficiencies and all forms of value-added
effectiveness," as stated by Rauscher Pierce.
But why does the industry think they can get away with it this time and
expect steady growth forever?
The justification explained ad nauseam at the conference was formerly
untapped international demand. Which basically means future global
economic booms in China, India and Russia. The theme: Oil and gas will
be in strong demand forever, supply can't keep up, prices will drift up
and we'll make good money forever.
But one doesn't go from driving a rickshaw one day to cruising around in
a gas-guzzling sports utility vehicle overnight. History tells us that
is at least a 50-year transition process. The energy industry is correct
in that the potential demand numbers from developing markets are
enormous. But if these expectations are fulfilled over a 50-to 100-year
period, and the industry is creating supply like it will happen
tomorrow, it doesn't take a tenured economist to tell us that's not
good. So what's the conclusion?
It became clear on the last day of the conference, standing out
remarkably well despite being placed on the back page of an
international oil and gas trade magazine called Upstream. Somebody was
forecasting an oil price of $100 per barrel! The source of this
prediction will be withheld out of courtesy, but there it was, in print!
This type of prediction occurs somewhere around the top of an energy
industry boom. History never repeats itself exactly, but it always
repeats itself.
So with this economic story in hand, and a reminder of the industry's
stellar performance last year, and with oil service stocks up around 80%
this year and sporting an industry multiple of 31, and E&P companies
carrying price-to-cash flow ratios off the chart, and the big oils up
better than 30% this year selling at all-time-high valuations, it's time
to consider risk. We are still in a raging bull market, so there might
be a little upside with these stocks, but that's speculating, not
investing, because the downside could be downright ugly. |
