The Real Oil Boom: Growing Five Times Faster

Think $88 oil is too high?

From the current macro view, it would certainly seem so.

Global GDP growth is expected to come in at a relatively meager 3% next year. Rising commodity prices have dented many consumers’ discretionary incomes. China’s central bank is hiking rates to keep inflation in check. Official unemployment in the world’s largest oil consuming economy is well above 9% and poised to stay there.

It’s not a pretty picture from the top-down. However, one of the best indicators of long run oil prices is signaling $88 is more than justified and reveals why one small sub-sector of the oil industry is growing nearly five times faster than the rest of them.

The Ultimate Oil Indicator

The thing we watch most closely when it comes to oil prices is what big oil companies are doing with their money.

They know the oil industry better than anyone. They know who’s buying how much at what price in real time. Also they play a major role in determining how fast supply can grow to meet demand.

That’s why it we consider Chevron’s (NYSE:CVX) most recent announcement to be very bullish. This week Chevron announced it was going to boost capital spending by 20% this year to $26 billion. That means Chevron will spend an additional $4 billion to explore, acquire leases and fields, build facilities, and grow its production.

Also, ConocoPhilips (NYSE:COP) recently announced it was going to ramp up its capital budget too. ConocoPhilips said it was increase its capital budget from $11 to $12 billion in 2010 to $13 to $14 billion in 2011.

All this is good news for oil prices, but it’s only half the story. The smartest money in the oil industry is doing the exact same thing.

Follow the Smartest Money in Oil

ExxonMobil (NYSE:XOM) is probably the best managed oil company in the world. Its margins are always among the widest. It has a long history of acquiring other companies and integrating them smoothly (a rare feat for most large companies). And it seems ExxonMobil is always one step ahead of the rest of the oil industry when it comes to getting big projects in new areas (i.e. LNG in Australia and Papua New Guinea).

More importantly, Exxon always seems to be making the right move at the right time. Whether ExxonMobil is buying out other energy companies at multi-year lows or bucking the trend when the rest of the markets were very scared.

The table below, which tracks ExxonMobil’s capital spending growth and oil prices, shows exactly what we’re talking about:

As you can see, ExxonMobil has steadily ramped up its capital spending over the past decade. Even at the height of the credit crunch when oil prices fell below $40 per barrel, Exxon was still increasing its capital spending. While many of ExxonMobil’s competitors were cancelling projects, selling assets, and making other “it’s all over” type moves, it was undeterred.

This year was no different. Exxon is on pace to invest the most in new capital projects than it has at any point in the last decade.

Next year it’s probably going to set another record. Pavel Molchanov, an analyst at Raymond James, recently estimated ExxonMobil’s capital budget would be $30 billion in 2011.

This news, although encouraging, is just one indicator of the good times ahead for the oil sector. You have to look behind these headline numbers to determine where to have your investment dollars working the hardest. That would most likely be in the fastest growing Oil sub-sector…

The Real Oil Boom: Growing Five Times Faster

The oil industry is currently working its way through a few major changes. The changes are expansive, take a long time, and Big Oil companies need a lot of help to get through them.

One of the biggest changes is the increasing growth and dependency on deepwater oil wells for new production.

You see, many onshore and shallow water offshore wells have been in decline over the last few years. And after nearly a century of picking up the low hanging fruit of oil reservoirs, there just aren’t that many left in these areas. As a result, deepwater offshore oil is booming.

Upstream, an oil industry newspaper, reported “production from deep water fields [will] increase by 99% by 2014 versus a forecast 20% rise in shallow water output.”

That’s five times faster. More importantly though, the growth of deepwater oil production affects the capital budgets of the major oil companies and puts a virtual floor in oil prices.

The Oil Price Limbo

As you might expect, it costs a lot more to drill a well one or two miles below the surface than it does a few hundred feet. The technology, reinforced equipment, and limited rigs make it very expensive.

Despite the obvious costs, that’s where the oil is. So that’s where the oil companies must go to get it.

With the conventional onshore and shallow offshore oil sources growing at a snail’s pace, they must turn to more expensive deepwater operations – regardless of the risk and price – to meet the world’s growing appetite for oil.

As a result, oil prices can’t really fall below $60 for a very long period of time. The 2008 credit crunch was the perfect example. Oil prices fell, but the smartest money in oil knew they wouldn’t be that low for long and kept on investing in new production.

So, do you think $88 per barrel is too high now?

The world’s top oil companies certainly don’t think so and the fundamentals of the fastest growing subsector of the oil industry certainly don’t.

By Andrew Mickey

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