Today crude oil and related oil producing assets are substantially “undervalued”
and misunderstood by Wall Street analysts and main street investors. With seemingly high prices for crude oil and refined products like gasoline, widespread disbelief exists that oil can climb yet higher. On the contrary, the sheer size of record money printing by the U.S. Federal Reserve and a lack of understanding of the Peak Oil problem presently give petroleum quotes a solid foundation to rise markedly in 2012-13, based on our work. We are confident a combination of factors will propel crude oil to US$500 a barrel before the year 2020.
Please read our Crude Oil is Going to $500 a Barrel (Part 1)
article explaining the elementary arguments for ever rising energy pricing going forward...
Whether it’s the backwardation of futures pricing for crude oil, or well below S&P 500 average valuations for Oil companies with P/Es of 8-12 “trailing” after-tax profits, Wall Street conventional wisdom expects oil quotes to FALL appreciably from US$105 a barrel in 2012-13, not RISE toward $200. Yes, the price of crude oil has risen a remarkable 900% since the 1999 ultra-low price of US$10 a barrel. However, commodities in general are 5-10 times the pricing of 1999, with hard money substitutes for paper currency like gold 500% and silver 800% higher the last 13 years.
Let’s compare the relative pricing of the two most important commodities on the planet, gold and oil. Specifically, gold is the ultimate hedge against inflation (reckless money printing) and “the” hard currency of choice throughout human history, while oil has been “the” engine fueling the movement of people, goods and economic growth the last century. Believe it or not, today’s US$1700 gold divided by US$105 crude oil price is right at the post World War II average ratio of 16. During 2005, the Gold/Oil Ratio was as low as 7 (equal to $240 crude oil per barrel at $1700 gold an ounce). Considering the high odds of a war shock to oil supplies coming soon, and the problems associated with Peak Oil supply already biting the oil market, any number remotely near the 70-year average should be viewed as a LOW price, not a high one, in our humble opinion!
Another relative value indicator to compare is the Dow Industrial price versus a barrel of crude oil. Today the Dow/Oil Ratio is around 123 (13,000 Dow/ US$105 crude oil). The average since leaving the gold standard in 1971 is 140, and if you exclude the stock market boom years of 1995-2005, that average is closer to 80. By this measure oil is again fairly valued to UNDERVALUED in early 2012. The 1974 Arab oil embargo low ratio was 40, the 1981 all-time low was 25 from the Iran-Iraq war, and the 1990 oil spike from Iraq invading Kuwait produced a 50 number. Assuming the stock market stays close to current pricing, there is plenty of room for oil to rise 50% or even 100% in price in 2012-13, especially if a new Middle East war with Iran erupts. How high could petroleum prices climb under a worst case scenario disruption of supply from the Middle East? To reach the 25 all-time low ratio (or all-time high valuation of oil vs. stocks), stock market wealth levels right now would require a rise above $500 a barrel in crude oil!
Of particular interest to investors in 2012, Oil company valuations do not discount or anticipate ANY potential rise in oil/gas prices going forward. They are quite inexpensive on a relative basis to current earnings and cash flows historically, including comparisons to the alternative stock investments you could make in the S&P 500 average company, and yields in the bond market. At this point they offer substantial upside, above and beyond a significant and sustainable advance in raw energy commodity prices in the future. At US$200 crude oil in 2013, most of the oil assets we hold in the Relative Value portfolio could be “returning” 20%-40% annually in after-tax free cash flow, on our invested dollars today. Where else in the marketplace can you find safe, risk-adjusted returns close to this potential? ...